ETERMINING W I T H D R A W A L RATESUSING HISTORICAL DATA
by William P. Bengen

At the onset of retirement, investment advisors make crucial recommendations toclients concerning asset allocation, as wellas dollar amounts they can safely withdraw annually, so clients will not outlive
their money. This article utilizes historical investment data as a rational basis forthese recommendations. It employs graphical interpretations of the data to determine
the maximum safe withdrawal rate (as apercentage of initial portfolio value), andestablishes a range of stock and bond asset
allocations that is optimal for virtually all
retirement portfolios. Finally, it provides
guidance on "mid-retirement" changes ofasset allocation and withdrawal rate.
WILLIAM P. BENGENT

he year is 2004. You have done acreditable job of building yourfinancial planning practice overthe last ten years. Your retirement clientsare particularly well-satisfied. You havedemonstrated to them the virtue of a diversified portfolio of investments to provide
income during retirement. The markets
have been kind, if not overly generous;
your client's portfolios have enjoyed returns well in excess of bank savings accounts and certificates of deposit. They
perceive you as having enriched their lives,
and they are grateful ....
It is 2006. The markets have turnedsour as a weak Federal Reserve Board has
allowed inflation to spiral out of control.
The stock market has plummeted 35 percent during the last 2 years, the worst
losses since the 19 73-19 74 recession. Manyof your clients are alarmed, worried thatthey will have to cut back on their lifestyles
to preserve capital in their retirement accounts. You soothe them, reminding themthat you carefully computed their rates ofwithdrawal based on average rates of returns experienced by the markets over theyears, and that the markets will recover.
October 199However, you cannot help feeling a gnawin g concern that y ou hav e ov erloo ked something ....
It is 2009. True to your forecast, thestock market has recovered nicely during
the last three years, and most clients'portfolios have regained almost all their lost
nominal value. However, your clients havea new complaint: they cannot live on thewithdrawals they have been making. Inflation, averaging eight percent over thelast five years, has so eroded their purchasing power that they must substantially increase their withdrawalsmor facea drastically reduced quality of life. When
you compute the effect on your clients'
portfolios of these much higher levels ofwithdrawals, you are shocked: many clients will deplete their assets in less than ten
years, even though in many cases their life
expectancies are much longer. You havevery bad news to tell them. What could
have gone wrong?
The above scenario is fiction, of course,
but it could easily have been played out
several times during this century. The
logical fallacy that got our hypothetical

4

1

7

planner into trouble was assuming that
average returns and average inflation
rates are a sound basis for computing
how much a client can safely withdraw
from a retirement fund over a long time.
As Larry Bierwirth pointed out in
his excellent article in the January 1994
issue of the this publication ("Investingfor Retirement: Using the Past to Model
the Future"), it pays to look not just at
averages, but at what actually has happened, year-by-year, to investment returns and inflation in the past. He demonstrated that the long-term effects ofcertain financial catastrophes, such as
the Depression or the 1973-1974 recession, can overwhelm the averages. Such"events" cannot be ignored, and the client should be made aware of them.
In this article, I will build on
Bierwirth's work, approaching it from aslightly different tack. Using the concept of "portfolio longevity," I will
present simple techniques planners canuse immediately in their practice in advising clients how much they can safely
withdraw annually from retirement accounts. I also will explore the issue of
asset allocation during retirement, including some surprising (at least to me)
conclusions. In all cases I will rely on
actual historical performance of investments and inflation, as presented in
Ibbotson Associates' Stocks,, Bonds, Billsand Inflation: 1992 Yearbook.
The Averages
To begin with, let's see how our hypothetical planner got into trouble. By referring to the Ibbotson data (which wewill assume had not changed significantly by 2004), our planner learned
that common stocks had returned 10.3
percent compounded over the years, andintermediate-term Treasuries had returned 5.1 percent. Inflation averaged 3

1

percent over the same period. Therefore, a client with a portfolio consistingof 60-percent stocks and 40-percent
bonds could expect an average compounded return of 8.2 percent, assuming continual rebalancing. The "real"
return, adjusted for inflation, would bealmost 5.1 percent.
This planner's clients wanted tospend as much as possible each year
from their retirement accounts, whilem a i n t a i n i n g a c o n s i s t e n t lifestylethroughout retirement. Given the above
analysis, it seemed to the planner thatthe clients could safely withdraw all the"real return" each year, or about five
percent, and leave the remainder in theportfolio. The clients could thus increase

turns and inflation stayed close to historical averages. The circumstance that
upset the arrangement was an "event,"
consisting of a severe stock-market
downturn and high inflation.
What similar events have actuallyoccurred in the past?
The Events
Table 1 lists the three largest stockmarket declines since 1926 that haveoccurred over periods of more than one
year. (The "crash" of 1987 does notappear, as stocks showed a gain for thefull year.) Because of my interest in
astronomy, I have nicknamed them, respectively, the "Big Bang," the "Big Dip-

Assuming a minimum requirement of 30 years of
portfolio longevity, a first-year withdrawal of 4 percent,followed by inflation-adjusted withdrawals in
subsequent years, should be safe.

their withdrawals each year by three
percent, keeping pace with inflation. At
the same time, the value of their portfolios would increase with inflation, satisfying their secondary goal of leaving
wealth for their heirs.
Thus, the planner recommended
that his clients withdraw five percent of
their portfolio's initial value at the end of
the first year, and annually increase theirwithdrawals by three percent, the anticipated rate of inflation. This plan worked
well for several years, as investment re-172

per," and the "Little Dipper," reflecting
their relative impact on the value andpurchasing power of investors' portfolios. These impacts will be more precisely quantified in the section below on
The Portfolios.
a The "Big Bang" of the 1973-74
recession was the most devastating because it occurred during a period of highinflation. Not only did investors suffer
large paper losses in their portfolios, but
the purchasing power of what remained
was reduced substantially. It was a fright-

ening period for investors.
a The "Big Dipper" of 1937-1941
featured a stock decline almost as great
as the "Big Bang," but it occurred during
a period of moderate inflation and somewhat higher bond returns. Therefore, its
impact on portfolios was not as severe,though it was still substantial, particularly as it followed the "Little Dipper" by
only half a decade.
a The "Little Dipper," of course,
was the early Depression years. It may
sound odd to list its impact as only third
behind the previous two events, given
the huge decline in stock prices that
occurred. However, as you can see from
Table 1, the early years of the Depression
was a deflationary period, so the impactof the decline in stock values was cushioned by an advance in purchasing power
for the dollar, as well as by modestly
positive bond returns.
There have been other events ofshorter duration, such as in 1946, but
the above represent the most significant
financial cataclysms of the last threequarters of this century. As planners, weknow such events are likely to recur inthe future. But just how detrimental
have these past events been on the longterm performance of a retirement portfolio?
The Portfolio Scenarios
In Figures 1 (a)-l(d), a series of graphs
illustrates the historical performance of
portfolios consisting of 50-percent intermediate-term Treasury notes and 50percent common stocks (an arbitrary
asset allocation chosen for purposes ofillustration). I have quantified portfolio

performance in terms of"portfolio longevity": how long the portfolio will last before
all its investments have been exhausted bywithdrawals. This is an intuitive approachthat is easy to explain to my clients,
whose primary goal is making it throughretirement without exhausting theirfunds, and whose secondary goal is accumulating wealth for their heirs. The
graphs themselves afford rapid comparisons between many different investment
scenarios. I have made several assumptions in preparing these graphs. Theseassumptions are detailed in the Appendix.

Journal of Financial PlanningIn Figure l(a), the first vertical baron the left represents the portfolio of aclient who began retirement on Jan. 1,
1926. He made a withdrawal of 3 percentof the portfolio the first year, followed
by inflation-adjusted withdrawals eachsucceeding year. The next bar represents the portfolio of a client who began
retirement on Jan. 1, 1927, and so on.
As you can see from the graph, the1926 client was able to make withdrawals from his portfolio in this manner for
50 years. Actually, the portfolio would
have lasted much longer than this. I havechosen 50 years arbitrarily as the longest
period to show on the charts, as few
clients enjoy more than 50 years of retirement.
Figure l(a) (three-percent withdrawal rate) is as exciting as a crewcut.
It shows that all clients, regardless of theyear they began their retirement, wereable to enjoy at least 50 years of inflation-adjusted withdrawals from theirportfolios. The graphs become more interesting as we increase the percentage
of first-year withdrawal. Figure l(b),featuring an initial withdrawal of four
percent, begins to show the effects ofsome financial events. However, theseeffects are comparably mild; no client
enjoys less than about 35 years before
his retirement money is used up.
Beginning with Figure 1(c), at afive-percent level of initial withdrawal,
these effects become much more pronounced. Clients beginning their retirement in the late 1960s and early 1970s
might have had only 20 years of funds
available at these rates of withdrawal-clearly not enough for their lifetime inmost cases!
In Figure 1 (d), the 3 majoc financial
events since 1926, which we discussed
earlier, are clearly identifiable. The deleterious impact of the 1973-1974 period
can be seen to reach back to retirement
portfolios whose withdrawals begin
many years earliermas much as 20 ormore years earlier! This is a powerfulwarning (particularly appropriate forrecent retirees) not to increase their rateof withdrawal just because of a few goodyears early in retirement. Their "excess
returns" early may be needed to balance
off weaker returns later.
The "Big Dipper" of 1937-1941 was

October 1994

FIGURE l(a)Number of Years Portfolio Assets Will Last (Withdrawals Vary Each Year with
Inflation)v-- 80I--,,i 6 0

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Y e a r Portfolio withdrawals begin (withdraw end of y e a r )less severe than the "Big Bang," andaffected portfolio longevity for only about
9 or 10 years prior to the eventmabout
half that of the "Big Bang." Least significant of the three was the "Little Dipper"of the Depression years, which affected
portfolio longevity for only four to five
years. This confirms our earlier observation that it is not a deflationary period
like the Depression that is to be truly
feared, but rather an inflationary periodthat wreaks havoc on purchasing power
as well as portfolio values.
I have not included charts for withdrawal amounts of seven percent andhigher, as they are too high to be practical for the new retiree. His or her retirement capital would be exhausted very
quickly in most cases.
Given the data expressed in thesecharts, how do we guide our clients tomake an intelligent decision about with-drawal rates?
Strategies and Applications
It is clear from Figure l(a) that an "absolutely safe" (to the extent history is a
guide) initial withdrawal level is 3 percent, in that it ensures that portfolio
longevity is never less than 50 years.
(This is also true for withdrawal rates ashigh as approximately 3.5 percent.)
However, most clients would find sucha low level of withdrawals unacceptable.
Assuming a minimum requirementof 30 years of portfolio longevity, a firstyear withdrawal of 4 percent [Figurel(b)], followed by inflation-adjusted
withdrawals in subsequent years, should
be safe. In no past case has it caused a
portfolio to be exhausted before 33 years,
and in most cases it will lead to portfolio
lives of 50 years or longer. By compari1 13

son, a 4.25-percent first-year withdrawal
could exhaust a portfolio in as little as 28
years, were past conditions to repeat
themselves.

Therefore, I counsel my clients to withdraw at no more than a four-percent rateduring the early years of retirement, espe-

what longer than that. Figure 1 (b) showsthat the 4-percent rate satisfies thosecriteria for all periods since 1926, including the major financial events.
What if a client feels he requires
larger withdrawals? For example, a client with a $400,000 portfolio would like

It is appropriate to advise the client to accept astock allocation as close to 75 percent as possible,
and in no cases less than 50 percent.

cially if they retire early (age 60 oryounger). Assuming they have normallife expectancies, they should live atleast 25-30 years. If they wish to leavesome wealth to their heirs, their expected "portfolio lives" should be some-to withdraw $24,000 the first year, thenincrease it with inflation each year. Thisis a six-percent withdrawal rate for the
first year. I show the client Figure 1 ( d ) ~the chart for 6-percent withdrawals-and explain the risks of such an ap-

FIGURE 1(c)Number of Years Portfolio Assets Will Last (Withdrawals Vary Each Year with
Inflation)

proach (assume for now that the client
has a 50/50 s t o c l ~ o n d allocation).
If the client expects to live another30 years, I point out that the chart shows
31 scenario years when he would outlive
his assets, and only 20 which would
have been adequate for his purposes (aswe shall see later, a different asset allocation would improve this, but it would
still be uncomfortable, in my opinion).
This means he has less than a 40-percent
chance to successfully negotiate retirem e n t - - n o t very good odds. If the client
suggests that he can prune back his
lifestyle to accommodate a major event
should it happen, I make sure he knows
how severe a pruning that may require.
Even then, it may be too little to late.
In addition, I point out that in mostcases, even if he is outlived by his money,
there may be little to pass on to heirs. If
this is a significant consideration to theclient, it may cause him to look at a moreconservative drawdown, at least in theearly years of retirement.
InitialAsset

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FIGURE l(d)Number of Years Portfolio Assets Will Last (Withdrawals Vary Each Year with
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Note that my conclusions above werebased on the assumption that the client
continually rebalanced a portfolio of 50percent common stocks and 50-percent
intermediate-term Treasuries. What effect would other asset allocation schemes
have on this conclusion? Would a higher
percentages of stocks, given their higher
rates of return, be beneficial to the client?
As a first look at the problem, examine Figure 2. This chart was created byproducing 40 graphs similar to those in
Figures 1 (a)-i (d). Five possible asset
allocations (0-, 25-, 50-, 75-, and 100percent stocks) were matched against 8
percentages of first-year withdrawals (1,2, 3, 4, 5, 6, 7, and 8 percent). All
permutations of these elements werecomputed as graphs, and the shortest
bar in each graphmrepresenting theshortest life of a portfolio for each combination of factorsmwas transferred to
Figure 2. What is depicted in Figure 2,
then, is a "Worst Case Portfolio Life"graph for each of many different scenarios.
One pattern that leaps out from thefigure is that holding too few stocks does

Journal of Financial Planningmore harm than holding too many stocks.
The "0-percent stocks" bar and "25percent stocks" bar are consistently
shorter than the others, confirming what
we already k n o w m t h e superior returnsof stocks versus bonds are essential tomaximizing the benefit from a portfolio.
Too few stocks in the portfolio shortens
the minimum portfolio life.
Perhaps even more important is theobservation that the 50/50 stock~ond
mix appears to be near-optimum forgenerating the highest minimum portfolio longevity for any withdrawal
scheme. This is particularly clear in the
4-percent, 5-percent, and 6-percent withdrawal groups, which are peaked likeroofs at the 50-percent stock level.
Does that mean that a 50/50 mix is
optimal for all situations during retirement? Not at all. Note in Figure 2 thatfor all withdrawal percentages, the bars
for 50-percent stocks and 75-percent
stocks are very close in heightma year orless apart. From the perspective of thehighest minimum portfolio longevity,that means you give up very little byincreasing stocks from 50 percent to 75
percent of the portfolio. But do you gain
anything in return?
To answer that question, consider
Figure 3 (a), which shows 4-percent withdrawal rate applied to a portfolio consisting of 75-percent stocks and 25-percent bonds. Compare this to Figure l(b),which is also drawn for a 4-percent withdrawal rate, but at a 50/50 stock~ondmix.
Clearly, the heavier weighting instocks in Figure 3(a) has produced somefairly significant improvements. Fully
47 scenario years result in portfolio
longevities of the maximum of 50 years,
while only 40 scenario years attainedthat pinnacle in the earlier chart. The
only penalties occur in portfolio year
1966, which is shortened by one year,
from 33 to 32 years, and in 1969, whichis shortened from 36 years to 34. All theother scenario years have equal or greater
longevity.
Is it possible that a stock allocation
as high as 75 percent is superior to a 50percent allocation for a retiree? Before
we accept that conclusion, let's perform
one more comparison. Examine Figure3(b), which computes longevity for a 5-

October 1

9

FIGURE 2
Minimum Number of Years Withdrawals Will Last
Assuming Worst Case from 1926-1976 Ibbotson Data

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FIRST-YEAR WITHDRAWAL AS % OF STARTING PORTFOLIO VALUEz

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FIGURE 3(b)Number of Years Portfolio Assets Will Last (Withdrawals Vary Each Year with
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FIGURE 4(a)Value of Portfolio at the End of 20 Years (Withdrawals Vary Each Year with Inflation)
GO

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1 S T - Y E A R W I T H D R A W A L AS % O F S T A R T I N G V A L U E O F P O R T F O L I O :
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FIGURE 4(b)Value of Portfolio at the End of 20 Years (Withdrawals Vary Each Year with Inflation)
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percent withdrawal rate with a 75/25
s t o c l ~ o n d allocation. As with the previous example, compare this graph to
Figure l(c), also for a 5-percent withdrawal rate, but with a 50/50 stock/bondallocation.
Once again, the improvements on
the 75/25 chart are quite evident. The"valleys" are narrower, suggesting thatdamage from financial events is confined to fewer years surrounding each
event. Twenty-four of the 51 scenario
yearsmalmost one half---have increased
longevities. Obviously, the recovery
power of stocks is at work here, snapping back from stock-market downturns
with greater vigor than bonds could evermuster.
However, there is a price to pay forthis improvement. The "Little Dipper"of the Depression is quite a bit deeper
than before. As we have seen, this was

176

,.,,

primarily a steep decline in stock prices
softened by deflation. As you might expect, increasing the percentage of stocks
in a portfolio only increases the damage
in such an event. As a result, there is anincreased chance of experiencing a retirement with near-minimum portfolio
longevity. Importantly, however, theshortest longevity is still during the "Big
Bang" (and this longevity has been unaffected by the higher stock allocation), so
we have not violated our criterion of 30
years minimum portfolio longevity.
As there is a trade-off in moving tostock allocations higher than 50 percent, there is clearly room for client
discretion. However, before a client
makes his or her decision, there is one
more piece of information to consider:
the additional wealth created by thehigher stock allocation.
Figures 4(a)-4(d) examine what

happens to the dollar value of a client's
period after 20 years have elapsed, under assumptions of different asset allocations. As your eye travels from Figure4(a), 35-percent stocks, through the 4charts to Figure 4(d), 75-percent stocks,
the increase is wealth is dramatic--asmuch as fourfold for some scenario years.
The average portfolio value increase from
35-percent stocks to 75-percent stocks
is +123 percent. Since the secondary
goal of our clients is accumulating wealthfor heirs, this is a significant consideration.
Sorting this all out, I think it is appropriate to advise the client to accept astock allocation as close to 75 percent as
possible, and in no cases less than 50
percent. Stock allocations lower than 50
percent are counterproductive, in thatthey lower the amount of accumulated
wealth as well as lowering the minimum
portfolio longevity. Somewhere between
50-percent and 75-percent stocks will
be a client's "comfort zone."
An asset allocation as high as 75
percent in stocks during retirement
seems to fly in the face of conventionalw i s d o m m a t least the wisdom I haveheard. But the charts do not liemthey
tell their story very plainly.
What occurs when we increase
stocks to more than 75 percent of theportfolio? This also turns out to be counterproductive. I have run an analysis ona number of scenarios using this assumption, and although accumulated
wealth continues to increase, it is offset
by the deterioration of portfolio longevity during the "Little Dipper" (Depression years). In fact, in most cases theminimum longevity during the Little
Dipper drops below the minimum longevity established on the 50-percent chart(which occurred during the 1973-74"Big Bang"), which is contrary to our
objective of "making sure the money
will last." Therefore, stock allocations ofmore than 75 percent are to be avoided
at the beginning of retirement.
Asset Allocation and Withdrawals
We begin retirement, therefore, with anallocation of between 50-percent and75-percent stocks (I assume 75 percent
in the discussion of particulars below).
Journal of Financial PlanningDo we maintain it during all of retirement, or change it as the client ages?
My research indicates strongly thatas long as the client's goals remain thesame, there is no need to change theinitial asset allocation. It is likely to do
more harm than good, as we shall see.
Let us consider first the case where
there is a change in the client's goals.
In this paper, our client's primary goalhas been to make the m o n e y lastthrough retirement, with a secondary
goal of maximizing the accumulationof wealth for heirs. The first goal issatisfied primarily by the selection of
the initial withdrawal percentage, although asset allocation plays a part.
The second goal is tackled by adjusting the asset allocation.
Consider a client aged 92, in poor
health, who expects to live at most a few
more years. Assume also that her retirement assets are more than adequate tolast for this period of time, even if invested in relatively low-yielding bankCDs. If her primary concern has shiftedto leaving maximum wealth to her heirs,a case could be made for selling all her
stocks, and converting to CDs or Treasury bills. Then her wealth would not bethreatened by a big decline in the stock
market, which can occur unpredictably.
Note that since we are assumingthat all retirement assets are held in taxdeferred accounts, capital-gains taxes
are not a concern. If the assets had been
held in a taxable account, the conclusion might have been different, as thecertainty of substantial capital-gains
taxes would have to be weighed against
the probability of a large stock-market
decline, and the loss of the benefit of astep-up in basis upon death.
Let's return now to clients who arewell into retirement (perhaps 10 to 15
years), but are still concerned about thelongevity of their portfolio, which must
support them for another 12 to 15 years
or more. For purposes of analysis, I
divide them into three classes: those
whose investment results have been exceptional ("the stars"), those who haveearned about what they expected ("theasteroids"), and those who, by virtue ofan event occurring during retirement,
have gotten poor investment results ("theblack holes").
October 1994

FIGURE 4(c)Value of Portfolio at the End of 20 Years (Withdrawals Vary Each Year with Inflation)
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FIGURE 4(d)Value of Portfolio at the End of 20 Years (Withdrawals Vary Each Year with Inflation)
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The Black HolesThe "black hole" group is in a very
uncomfortable situation. As an example,
the client who retired in 1929 with
$500,000 in a retirement fund saw thatfund dwindle to less than $200,000 by
the end of 1932. Although his withdrawals have also declined from $20,000 in
1929 to $15,300 in 1932, owing to deflation, those withdrawals now equal about
7.6 percent of his portfolio, whereas hebegan by withdrawing only 4 percent. In
this situation, with stocks having performed so dismally so early in retirement, it may be tempting to switch all
investments to bonds in order to salvage
what is left of the original capital.
But that would be precisely thewrong thing to do! Let us say that on
December 31, 1932, after years of withering returns on stocks, our black-holeclient demands we reduce the percentage of stocks in his portfolio. If we eliminate stocks completely, investing only
in intermediate-term bonds, his money
will be exhausted in 1946, after only 17
more years. If we invest in 25-percent
stocks, the money will last till 1950; 50
percent in stocks, 1957. Butifwe hadleft
the allocation at 75-percent stocks, theclient would still have $1.7 million in
1992 (although to maintain his lifestyleafter inflation, he would be withdrawing
9.5 percent a year, which suggests theportfolio would probably not last muchbeyond the millennium, if that).
But what if our client had the audacity to demand, on December 31, 1932,
that we increase the stock allocation to
100 percent, and hold that allocation for
the remainder of his life? Despite suffering through the "Big Bang" and the "Big
Dipper," by 1992, if he were still alive, he
1 77

would have amassed $42 million in his
retirement fund! Of course, with all that
wealth, there would have been the temptation to increase withdrawals, thereby
reducing the accumulation, but that certainly would have been affordable.
This same analysis can be repeated
for all the other "black hole" clients who
were unfortunate enough to begin theirretirements in 1937, 1946, 1969, 1973,
1 9 7 4 ~ t h e years of major and minor
events. This is a testament to the enormous recovery power of the stock mark e t ~ a n d the need to avoid emotion
when investing. The best time to invest
is likely to be right after the worst time toinvest!
Admittedly, increasing stock allocation to 100 percent after a long periodof miserable returns requires unusual
foresight and fortitude on the part of theadvisor, as well as the client. If you canconvince your clientjust to maintain the
75-percent allocation under such conditions, you have won a major battle. However, the client is still faced with a shorterthan-average portfolio longevity, andwith much less wealth to pass on to heirs
than originally hoped for.
However, the client has anotheroption to improve the situation for thelong term, and that is to r e d u c e ~ e v e n if
temporarilymhis level of withdrawals.
If the client can manage it without too
much pain, this may be the best solution, as it does not depend on the fickle
performance of markets, but on factors
the client controls completely: his spending.

only 5 percent, and continues to withdraw at this reduced level during retirement, by 1949 he will have 20 percent
more wealth than otherwise, which canbe passed on to his heirs. After 30 years,
the wealth is 25 percent greater, and theadvantage continues to grow over time.
This assumes he continues to maintainthe 75-percent stock allocation throughout retirement.
Thus the "black hole" client has atleast two alternatives to improve his
portfolio longevity, with an infinite number of permutations of the two possible.
The one alternative he cannot afford,
and which we as advisors must work
hard to dissuade him from doing, is topull back from the stock market andretreat to bonds.
The Stars
At the other end of the spectrum are the"stars," the lucky clients who began retirement early in a boom period in thestock market; for example, 1949, the1950's, 1975-1976, and even 1982. Theirproblem is quite the opposite of the"black hole" clients; their resources grew
very rapidly early in retirement, andthey are tempted to do two things: toincrease their withdrawals, and to increase their allocation in the stock market. Both could be damaging to theirretirement.
Consider a client who retired in
1958, again with $500,000, and whotakes your advice to withdraw 4 percent
each year, adjusting the withdrawals for

Increasing stock allocation to 1 O0 percent after a long period of
miserable returns requires unusual foresight and fortitude on thepart of the advisor, as well as the client.

As an example, let us return to the1929 retiree. At the end of i930, as he isabout to make his second annual withdrawal, the market has already declined
about 30 percent from the end of 1928,
and there looks like more trouble ahead.
If he reduces his 1930 withdrawal by

178

inflation each year. Over the 10 years
from i958-1967, the stock market returned 12.9 percent a year compounded,
while inflation increased at only a measly 1.8 percent a year. These are bothmuch better than the long-term averages.

Despite her withdrawals, the client has over $ i million in her retirement fund, and realizes she is withdrawing at the rate of only 2.3 percent
a year. Over your strenuous objections, she increases her withdrawals
to $40,000 a year, almost 4 percent ofher portfolio value.
What happens the next few years
thoroughly shocks her. After a bad 1969,
her portfolio is further assaulted by the"Big Bang" of 1973-1974. Her funddwindles in value to $777,000 at the endof 1974. Worse, high inflation has reduced its purchasing power to less than
$ 500,000, compared with the $1,040,000
she had at the end of 1967mless thanhalf its value. And most frightening ofall, she is withdrawing at the rate of eightpercent a year!
Panic may well grip such an investor, causing her to search for drastic
remedies. Not wishing to diminish her
lifestyle (to which she has become accustomed over the last six years) she
may instruct you now to reduce thepercentage of stocks in her portfolio,
perhaps to zeromat precisely the wrong
time. Sound familiar? Yes, the "star" is
now a "fallen star," and has been converted to a "black hole."
The remedies for the client are thesame as they were for the "black hole"clientmstay the course, and expect adramatic recovery in stocks (which weknow occurred); reduce withdrawals;
or, most dramatically, consider increasing the stock allocation to 100 percent of
the portfolio. Can you imagine how much
wealth would have accrued to an investor who had a 100-percent stock portfolio on January 1, 1975, and held it
through the end of 19937 Even after
withdrawals, which began at four percent, she would have increased her
wealth by seven times!
So the "star" clients are ones who
must be advised to refrain from making
any radical changes in their asset allocation or withdrawal pattern. Some increase in withdrawals are probably inevitable, but need not be fatal to theretirement plan, if they are moderate.
They must understand that excess returns earned today will probably beneeded to offset losses in the future.
They have enjoyed good luck, and noth-

Journal of Financial Planninging more. Good luck is too rare andprecious to be squandered.
The Asteroids
The "asteroid" clients are the ones who,
after ten years, have gotten just about
what they expected out of the markets
regarding investment return and inflation. They are typified by those who
retired in the years 1942-1946, or 19591960. Since their expectations have beenmet, it is unlikely that they will want tomake any major changes in their portfolios regarding asset allocation or withdrawals. And that is almost certainly thebest strategy.
Because the stock market is a random place, it is impossible to predictwhether asteroid clients will experience
better or worse luck during their second
decade. Those who retired in the 40's
had a wonderful second decade; those
who retired in 1959-1960 had a miserable second decade. Fortunately, theirdecent start in the first decade gives
them a cushion, should they need it.
They can ride out a period such as the"Big Bang" without having to reduce
withdrawals or change allocations. And
after the "Big Bang" they will have an
opportunity to accelerate the growth oftheir wealth by using the all-stock strategy we discussed above.

Second!.changes in:portfolio valueslNere c o ~ u t e d :as::follows:.assume aportfoIio had an initial value of $ lmillion, c0nsisfing of $500 i000 in stocks and$500.;000 :in Treasuries :(50/50. allocation)i During the :first year;according to
Ibbotson data, stocks .returned ten. percent and b o n d s returned five percent:
Therefore, stocks increased in value.to $550,000: during the year, and bonds
to $525 ;000; giving a new portfolio value of $1 ;075,0.00:: The initial withdrawal

increased by 3 percent t o $41,200: This leaves $1i033,800 in the portfolio.
Note that: withdrawals are assumed:to occur at the end of each calendar year.
At the beginning:of the second yeari the portfolio is rebalanced to:the 50/
50 allocation; stocks begin the year with a value of $516,900, a s d o bonds.

grow:to: 547,914. This gives a new portfolio value of $1,126,842. Last year's
withdrawal of $41,200 is increased by the inflation rate of 2 percent during thesecond year, giving a withdrawal amount.of $42,024 anda final portfolio valueof $ li084;8181 This process is r ~ e a t e d for each succeeding year. Obse~e thatthe second year's withdrawal :of $42,024 is:approximately 4.1 percent of the:Conclusion
For a client just beginning retirement,
determine first the "safe" withdrawal
rate. Do so by computing the shortest
portfolio life acceptable to the client(generally the client's life expectancy
plus 5 or 10 years, depending on theconservatism of the client). Next, using
the charts for a 50/50 stock/bond allocation, determine the highest withdrawal
rate that satisfies the desired minimum
portfolio life. For a client of age 60-65,
this will usually be about 4 percent.
The withdrawal dollar amount for
the first year (calculated as the withdrawal percentage times the starting
value of the portfolio), will be adjusted
up or down for inflation every succeeding year. After the first year, the withdrawal rate is no longer used for computing the amount withdrawn; that will
October 1994

be computed instead from last year's
withdrawal, plus an inflation factor.
Should a client wish higher levels of
initial withdrawals, he or she should be
apprised of the risks, using charts similar to those in Figure 1. You should do all
you can to dissuade the client from being too "frisky" with spending early inretirement. An initial five-percent withdrawal rate is risky; six percent or moreis "gambling."
Despite advice you may have heard
to the contrary, the historical record
supports an allocation of between 50percent and 75-percent stocks as thebest starting allocation for a client. For
most clients, it can be maintained
throughout retirement, or until theirinvesting goals change. Stock allocations
below 50 percent and above 75 percent
are counterproductive.
Very conservative clients may havedifficulty accepting a 75-percent stock
allocation. Using the charts, you canreview with them the performance difference between a 50-percent stock allocation and a 75-percent stock allocation,
and allow them to make the choice. A
negative feature of a higher stock allocation is reduced portfolio longevity as a
1 79

result of a Depression-like event. A major positive is the vastly increased wealththat will accrue under most other scenarios. I believe that the balance is tilted
in favor of the higher allocationmbut itis the client's choice.
With respect to their investment
experience, retirement clients fall into
three groups. "Star" clients earn highreturns for extended periods early on in
their retirement, so they develop wealthmuch faster than expected. They must
be counseled not to increase withdrawals excessively, or to be too aggressivewith their asset allocation. "Black hole"clients experience a major unpleasantfinancial event early in their retirement,
and may become too conservative. They
should be counseled to maintain theirasset allocation, and reduce withdrawals slightly for a period of time. The mostcourageous such clients should consider
increasing their stock allocation to as
much as 100 percent for the rest of theirretirement.
Finally, "asteroid" clients, who haveexperienced average results over theirfirst ten years of retirement, probably
will not request, and should not be recommended, a change in either asset allocation or withdrawal strategy. The experience of their second decade may bedifferent, and the planner can formulate
his or her recommendations accordingly
at that time.
Epilogue

It is the year 2014. A strong Federal Reserve Board, under new leadership, hasbrought inflation under control, and themarkets have enjoyed a multi-year boom.
Your old clients' fortunes have been restored, and they are enjoying their retirement once again. You heave a mental sighof relief, because the outcome could havebeen vastly different.
You have been planning for new clients using the methods described above,and it is very comforting to know thatregardless of what may come in the future,
your clients will survive; their retirement
is not dependent on the Fed or interest
rates or the vicissitudes of the markets.
You have prepared them to survive theworst that has ever occurred, and should
circumstances be better than that, they180

will prosper.
After all, isn't that what they hired
you for? And isn't that what you wish forthem?J
References
1.

2.

3.

Less Antman, "First, Let's Kill All
the Asset Allocators," Managing Your
Money Better, Spring 1994, pp. 6-8,
(MECA Software, Inc., Fairfield,
Conn.).
Larry Bierwirth, "Investing for Retirement: Using the Past to Model
the Future," Journal of Financial
Planning, January 1994, pp. 14-24.
IbbotsonAssociates, "Stock, Bonds,

Bills and Inflation: 1992 Yearbook"(Chicago: Ibbotson Associates,
1993).

WILLIAM P. BENGEN, CFP, M.S., is asole practitioner in El Cajon, California,
specializing in investment management.
He received a bachelor of science degreefrom the Massachusetts Institute of Technology in aeronautical engineering, thenjoined his family-owned soft-drink franchise firm in the New York metropolitan
area. After 17 years with the company,
during which he served a tenure as president and CO0, the business was sold. He
and his family moved to southern California, where he began his financial planning
practice, earning his master's degree infinancial planning in 1993.