It’s no secret that most Canadians are unsure about just how much they should be saving for retirement. But a survey by investment firm Edward Jones suggests retirees may be equally confused about how much they can safely spend once they get there.
Among the participants in the survey, when asked what percentage of their savings they think they can afford to withdraw every year in retirement, 49% felt they would like to withdraw at least 6% of their savings. Alarmingly, 19% thought they could pull out as much as 20%.
Although income sustainability is a major concern for retirees, most experienced financial advisors understand that the safe withdrawal rate in retirement isn’t something that can be neatly packaged into a rule of thumb.
Nonetheless, when pressed, many advisors will suggest clients can safely withdraw 4% on an inflation-adjusted basis from retirement accounts over the course of their lifetime without fear of running out of money.
However, according to Wade Pfau, professor of economics at the National Graduate Institute for Policy Studies in Japan, the target percentage today’s retirees can confidently withdraw and not outlive their financial capital may be much closer to 2%.
Pfau’s findings, recently published in the Journal of Financial Planning, dispute the standard rule of thumb – largely because it is based entirely on U.S. investment data covering a period when the U.S. was the world’s leading economy. Retirees in other parts of the world have enjoyed a much different experience.
Using 109 years of data for each of 17 developed countries, Pfau has determined that a 4% withdrawal rate using a 50/50 asset-allocation split between stocks and bonds would have been unsustainable more often than not. In fact, retirees in six countries – Spain, Italy, Belgium, France, Germany and Japan – were unable to sustain annual withdrawal rates above 3%.
Rather than using any fixed percentage, the safe withdrawal rate is largely dependent on economic conditions and asset valuations prevailing at the time clients retire, Pfau maintains. Low valuations portend better returns and, therefore, higher sustainable withdrawals. High valuations suggest lower withdrawal rates down the road.
Pfau employs three valuation metrics – PE10 (price divided by average real earnings for the previous 10 years), dividend yield (dividends divided by stock price) and interest rates on 10-year government bonds – to determine what the future might hold for retirees.
Thanks to overvalued markets and razor-thin interest rates that don’t exist in historical data, this decade’s retiree is probably looking at a 2% safe withdrawal rate.
This may seem to be a rather dire outlook. However, simply relying on conventional wisdom could tempt recently retired clients to overspend, thus putting them at risk of running out of money long before they run out of life.
On the other hand, for those who already have retired and follow the 4% rule, it is clearly time to re-evaluate, Pfau argues, given that most portfolios are already likely to be underperforming original projections.
© 2012 Investment Executive. All rights reserved.