Is 6% Normal After All?

There are times when you can withdraw 6% of your original balance (plus adjustments to match inflation) safely using a traditional approach. Such times are unusual for those who invest in stocks and TIPS. But what about those who invest in stocks and corporate bonds?

Normal Times

During normal times, P/E10=13 or 14. Today’s P/E10=24 is unusually high.

The Traditional Approach

The traditional approach used in Safe Withdrawal Rate studies sells stock shares as necessary with a stock/bond (S&P500/TIPS) portfolio. You vary withdrawals to match inflation. The withdrawal rate is the original amount withdrawn divided by the original portfolio balance.

Corporate Bonds

Corporate bonds carry an interest rate higher than Treasury bonds. The spread is usually 1% or more. Traditional models do a poor job of simulating corporate bonds. They treat them as single year trading vehicles, sometimes with capital gains and sometimes without. In this study, I treat corporate bonds as if they were TIPS at a 3% (real) interest rate. An intelligent bond investor should be able to do at least this well.

Year 30 SWR Retirement Risk Evaluator

I set P/E10=14, TIPS interest rate=3.0% and the Year 30 final amount of 0%. These are the results:

Safe Withdrawal Rate
20% stocks with rebalancing: 5.05%.
50% stocks with rebalancing: 5.48%.
80% stocks with rebalancing: 5.34%.
100% stocks: 5.21%.

Reasonably Safe Rate (80% success)
20% stocks with rebalancing: 5.25%.
50% stocks with rebalancing: 5.83%.
80% stocks with rebalancing: 6.04%.
100% stocks: 6.11%.

Likely Success Rate (50%-50%)
20% stocks with rebalancing: 5.45%.
50% stocks with rebalancing: 6.18%.
80% stocks with rebalancing: 6.74%.
100% stocks: 7.01%.

Almost Certain Failure Rate
20% stocks with rebalancing: 6.05%.
50% stocks with rebalancing: 7.08%.
80% stocks with rebalancing: 8.34%.
100% stocks: 9.01%.

This shows that a 6% (plus inflation) withdrawal rate is reasonably safe (80% success) in a normal market. It requires a high stock allocation.

Scenario Surfer Runs

I invested entirely in stocks and corporate bonds (as simulated by 3% TIPS). I started with a $100000 balance. P/E10=14 Normal Market initially. I withdrew $6000 (plus inflation) each year. I set the TIPS interest rate to 3.0%. Here are the Year 30 balances. I have included fixed allocation results for comparison.

Run 1. 317,605.
20% rebalanced: bankrupt in year 25.
50% rebalanced: bankrupt in year 29.
80% rebalanced: bankrupt in year 29.

Run 2. 115,481.
20% rebalanced: bankrupt in year 26.
50% rebalanced: 11,620.
80% rebalanced: 32,835.

Run 3. 84,753.
20% rebalanced: bankrupt in year 25.
50% rebalanced: bankrupt in year 28.
80% rebalanced: 6,154.

Run 4. 143,250.
20% rebalanced: bankrupt in year 28.
50% rebalanced: 61,133.
80% rebalanced: 157,185.

Run 5. 67,636.
20% rebalanced: bankrupt in year 27.
50% rebalanced: 8,005.
80% rebalanced: 23,038.

Run 6. 162,447.
20% rebalanced: bankrupt in year 26.
50% rebalanced: 26,356.
80% rebalanced: 90,628.

Run 7. bankrupt in year 26.
20% rebalanced: bankrupt in year 24.
50% rebalanced: bankrupt in year 25.
80% rebalanced: bankrupt in year 25.

Run 8. bankrupt in year 25.
20% rebalanced: bankrupt in year 25.
50% rebalanced: bankrupt in year 26.
80% rebalanced: bankrupt in year 24.

Run 9. 140,344.
20% rebalanced: bankrupt in year 27.
50% rebalanced: 62,367.
80% rebalanced: 184,940.

Run 10. 81,610.
20% rebalanced: bankrupt in year 29.
50% rebalanced: 58,398.
80% rebalanced: 129,692.

Training improves results over mechanically defined algorithms. A high stock allocation improves the chance of success. In a normal market, 6% (plus inflation) usually succeeds with training. Varying allocations in accordance with P/E10 usually beats using a fixed allocation, but not always.

Varying allocations still encountered 2 failures out of 10. This suggests (but does not prove mathematically) that withdrawing 6% (plus inflation) is only reasonably safe. That is, it is not a safe withdrawal rate (95% probability of success).

Summary

With an S&P500/corporate bond portfolio, withdrawing 6% of the original balance (plus inflation) would be reasonably safe at P/E10=14. Today, P/E10=24.

Have fun.

John Walter Russell
May 13, 2008