Earn CE credits
“Compendium of sustainable withdrawal rates, part 2” is eligible for CE credits, see Accreditation details for more information
Course summary: Financial planner and market theoretician Jim Otar walks advisors through sustainable withdrawal rates (SWR) for many different variables, asset allocation methods and withdrawal strategies. You must successfully complete the course, “Purpose-Driven Sustainable Withdrawal Rates,” as well as “Compendium of Sustainable Withdrawal Rates, Part 1,” before taking this course.
Continuing from Part 1 of this course, in this part we examine the following strategies:
- Asset Allocation: growth harvesting and asset dedication
- Time Segmentation: bucket strategies
- Withdrawal Strategies: freeze Cost of Living Adjustment (COLA), limit withdrawals based on portfolio growth or value, pay-cut
- Various Equity Benchmarks: Canada, USA, Britain, Japan, Australia
Growth Harvesting
This is identical to our base case, with the following exception: when the equity portion of the portfolio grows by more than 8% at the end of the year, we take 50% of that growth and place it into a separate cash bucket for future retirement income. The target asset mix and rebalancing applies only to the remaining portfolio, excluding the cash bucket. Typically, as time goes on, there is more cash and less equities in the combined assets.
Here are the sustainable withdrawal rates:
Retirement Age: | SWR for ESSENTIAL Expenses | |
---|---|---|
Growth Harvesting | Base Case | |
60 | 2.76% | 3.03% (55/45) |
65 | 3.05% | 3.31% (55/45) |
70 | 3.44% | 3.68% (55/45) |
75 | 4.04% | 4.29% (55/45) |
Retirement Age: | SWR for BASIC Expenses | |
---|---|---|
Growth Harvesting | Base Case | |
60 | 3.48% | 3.67% (60/40) |
65 | 3.86% | 4.01% (60/40) |
70 | 4.52% | 4.51% (60/40) |
75 | 5.49% | 5.31% (60/40) |
Retirement Age: | SWR for DISCRETIONARY Expenses | |
---|---|---|
Growth Harvesting | Base Case | |
60 | 4.18% | 4.48% (70/30) |
65 | 4.63% | 5.13% (70/30) |
70 | 5.39% | 5.93% (65/35) |
75 | 6.35% | 7.07% (55/45) |
Here is a typical average asset mix over the life of the retiree:
Figure 1: Typical average asset mix for the Growth Harvesting Strategy
Generally, growth harvesting produces a lower SWR than the base case. This is because near the SWR, there is little need for the cash bucket; it just sits there as deadweight. However, at higher withdrawal rates, it has some benefit in reducing the probability of depletion.
Example: A retiree has $100,000 at age 65 with 50% equities/50% fixed-income asset mix. He needs $4,500/year indexed to CPI for the rest of his life. Here are the probabilities of depletion:
By Age: | Probability of Depletion | |
---|---|---|
Growth Harvesting | Base Case | |
85 | 0% | 1% |
90 | 10% | 14% |
95 | 25% | 36% |
Asset Dedication
This is identical to our base case with the following exception: The fixed income portion of the portfolio never holds less than 4 years’ of withdrawals. If the entire portfolio has less than 4 years’ of withdrawals, then there are no equity holdings, only fixed income.
Here is a typical average asset mix over the life of the retiree. The portfolio has a starting asset mix of 50% equities/50% fixed income and the initial withdrawal rate is 4%. Note that at around age 82, the equity percentage starts declining so that the fixed-income portion of the portfolio can hold 4 years of income:
Figure 2: Typical average asset mix for the 4-Year Asset Dedication
Here are the sustainable withdrawal rates:
Retirement Age: | SWR for ESSENTIAL Expenses | |
---|---|---|
Asset Dedication | Base Case | |
60 | 3.00% | 3.03% (55/45) |
65 | 3.26% | 3.31% (55/45) |
70 | 3.60% | 3.68% (55/45) |
75 | 4.06% | 4.29% (55/45) |
Retirement Age: | SWR for BASIC Expenses | |
---|---|---|
Asset Dedication | Base Case | |
60 | 3.62% | 3.67% (60/40) |
65 | 3.99% | 4.01% (60/40) |
70 | 4.41% | 4.51% (60/40) |
75 | 5.09% | 5.31% (60/40) |
Retirement Age: | SWR for DISCRETIONARY Expenses | |
---|---|---|
Asset Dedication | Base Case | |
60 | 4.48% | 4.48% (70/30) |
65 | 5.01% | 5.13% (70/30) |
70 | 5.81% | 5.93% (65/35) |
75 | 6.87% | 7.07% (55/45) |
Asset dedication does not improve portfolio longevity because it kicks in at the late stages only—long after the tipping point. Surely, you can allocate more years to the fixed-income portion hoping it will improve the outcome. We will look at this in the next section.
Standard Bucket Strategies
Assets are divided into a number of buckets at the beginning of retirement. Usually, the first bucket is the most conservative, with cash only. The last bucket is the most aggressive. Withdrawals are taken from the first bucket until it depletes. Once it is depleted, then withdrawals are from the next bucket until that one depletes, and so on. This is also called “time-segmentation of withdrawals.” (For more information on bucket strategies, please see the course “Kicking the Bucket Strategy.”)
Here is how we’ve constructed our buckets:
1 bucket:
Base Case, 100% of assets
2 buckets:
Bucket #1: Cash, 25% of assets
Bucket #2: Balanced portfolio, 50%/50% asset mix, 75% of assets
3 buckets:
Bucket #1: Cash, 25% of assets
Bucket #2: Conservative portfolio, 30%/70% asset mix, 37.5% of assets
Bucket #3: Growth portfolio, 70%/30% asset mix, 37.5% of assets
4 buckets:
Bucket #1: Cash, 25% of assets
Bucket #2: Conservative portfolio, 30%/70% asset mix, 25% of assets
Bucket #3: Growth portfolio, 70%/30% asset mix, 25% of assets
Bucket #4: 100% Equity portfolio, 25% of assets
5 buckets:
Bucket #1: Cash, 20% of assets
Bucket #2: Bonds, 20% of assets
Bucket #3: Balanced portfolio, 50%/50% asset mix, 20% of assets
Bucket #4: Growth portfolio, 70%/30% asset mix, 20% of assets
Bucket #5: 100% Equity portfolio, 20% of assets
Here are the sustainable withdrawal rates:
Retirement Age: | SWR for ESSENTIAL Expenses | ||||
---|---|---|---|---|---|
2 Buckets | 3 Buckets | 4 Buckets | 5 Buckets | Base Case | |
60 | 3.14% | 3.30% | 3.13% | 3.26% | 3.03% (55/45) |
65 | 3.42% | 3.60% | 3.42% | 3.58% | 3.31% (55/45) |
70 | 3.83% | 4.02% | 3.97% | 4.06% | 3.68% (55/45) |
75 | 4.47% | 4.68% | 4.49% | 4.68% | 4.29% (55/45) |
Retirement Age: | SWR for BASIC Expenses | ||||
---|---|---|---|---|---|
2 Buckets | 3 Buckets | 4 Buckets | 5 Buckets | Base Case | |
60 | 3.62% | 3.71% | 3.52% | 3.57% | 3.67% (60/40) |
65 | 4.00% | 4.11% | 3.85% | 3.99% | 4.01% (60/40) |
70 | 4.50% | 4.59% | 4.31% | 4.46% | 4.51% (60/40) |
75 | 5.22% | 5.35% | 5.17% | 5.24% | 5.31% (60/40) |
Retirement Age: | SWR for DISCRETIONARY Expenses | ||||
---|---|---|---|---|---|
2 Buckets | 3 Buckets | 4 Buckets | 5 Buckets | Base Case | |
60 | 4.32% | 4.28% | 4.20% | 4.19% | 4.48% (70/30) |
65 | 4.77% | 4.71% | 4.64% | 4.62% | 5.13% (70/30) |
70 | 5.45% | 5.39% | 5.36% | 5.35% | 5.93% (65/35) |
75 | 6.48% | 6.39% | 6.47% | 6.52% | 7.07% (55/45) |
We observe that for essential expenses, bucket strategy provides a somewhat larger SWR than the base case. For basic expenses, the difference is insignificant. For discretionary expenses, the SWR from the bucket strategy is lower than the base case.
Rolling Bucket Strategies
This is a variation of the standard bucket strategy: The retiree starts with five buckets. When its cash bucket depletes, he takes all his remaining assets and restarts a four bucket strategy. When its cash bucket runs out of money, he takes all remaining assets and restarts anew with three buckets. When its cash bucket depletes, he takes all remaining assets and restarts with two buckets. Finally, when its cash bucket depletes, there is only one bucket left and he invests that in a balanced portfolio (base case).
The following graphs show the average overall asset mix for these two strategies at the sustainable withdrawal rate.
Figure 3: Average Overall Asset Mix for the Standard 5-Bucket Strategy
Figure 4: Average Overall Asset Mix for the Rolling 5-Bucket Strategy
Aftcast calculations for the rolling bucket strategy are complex and time-consuming. We explored a handful of scenarios and found that they produce generally lower SWR’s than the standard bucket strategy.
Bucket strategies do not extend portfolio life, but they do make a good marketing story.
Freeze the Cost of Living Adjustment (COLA) after an Adverse Performance
With this strategy, if the portfolio does not grow during the year, the retiree foregoes the CPI indexation in the following year. While this might look benign on the surface, it can be devastating for essential and basic expenses, even at low withdrawal rates. That is because once the retiree experiences his first no-growth year, he will have a deficit in his real purchasing power for the rest of his life.
Example: A retiree has $100,000 at age 65 with 50%/50% asset mix. He needs $4,000/year indexed to CPI for the rest of his life. Here is his income carpet:
To improve his outlook, he decides to forego a COLA adjustment after a bad year. Here is his new income carpet:
The results are much worse. On the income carpet, the green areas have almost disappeared. Clearly, this strategy is not suitable for essential and basic expenses; it is suitable only for discretionary expenses. Here are the sustainable withdrawal rates:
Retirement Age: | SWR for DISCRETIONARY Expenses | |
---|---|---|
Freeze COLA | Base Case | |
60 | 6.21% | 4.48% (70/30) |
65 | 6.66% | 5.13% (70/30) |
70 | 7.31% | 5.93% (65/35) |
75 | 8.50% | 7.07% (55/45) |
Don’t be misled by the higher SWR that this strategy generates. When you average out the ongoing loss of real purchasing power in later years, it works out about the same as the base case.
Pay Cut after Adverse Performance
In any given year, if the portfolio does not grow, the retiree takes a pay cut during the following year. Here are the sustainable withdrawal rates:
Retirement Age: | SWR for ESSENTIAL Expenses | ||
---|---|---|---|
20% Pay-Cut | 10% Pay-Cut | Base Case | |
60 | Not Suitable | 3.14% | 3.03% (55/45) |
65 | Not Suitable | 3.42% | 3.31% (55/45) |
70 | Not Suitable | 3.79% | 3.68% (55/45) |
75 | Not Suitable | 4.43% | 4.29% (55/45) |
Retirement Age: | SWR for BASIC Expenses | ||
---|---|---|---|
20% Pay-Cut | 10% Pay-Cut | Base Case | |
60 | 3.85% | 3.75% | 3.67% (60/40) |
65 | 4.21% | 4.10% | 4.01% (60/40) |
70 | 4.78% | 4.65% | 4.51% (60/40) |
75 | 5.58% | 5.44% | 5.31% (60/40) |
Retirement Age: | SWR for DISCRETIONARY Expenses | ||
---|---|---|---|
20% Pay-Cut | 10% Pay-Cut | Base Case | |
60 | 4.77% | 4.61% | 4.48% (70/30) |
65 | 5.50% | 5.30% | 5.13% (70/30) |
70 | 6.23% | 6.07% | 5.93% (65/35) |
75 | 7.47% | 7.25% | 7.07% (55/45) |
This strategy appears to have a slightly larger SWR than the base case. However, when you account for the pay cuts, it works out to about the same SWR as the base case.
Example: A retire has $100,000 at age 65 with a 60%/40% asset mix for his discretionary expenses. He would like to have $5,000/year indexed to CPI for the rest of his life. However, he is willing to take a 12% pay-cut if his portfolio does not grow. Here is his income carpet:
Limit Withdrawals to Portfolio’s Growth
With this strategy, this year’s withdrawal can never exceed last year’s portfolio growth. The portfolio never depletes, but there will be many years with no income (historically, equity markets have negative returns one in three years on average). This strategy is suitable for discretionary expenses only.
Example: A retiree has $100,000 at age 65 with 50%/50% asset mix. He needs $4,000/year indexed to CPI for the rest of his life. He decides that his withdrawals should never exceed the portfolio’s growth. Here is the aftcast:
With this strategy, there is no SWR because if withdrawals never exceed growth, the portfolio never runs out of money.
Limit Withdrawals to Portfolio’s Value
With this strategy, this year’s withdrawals can never exceed a fixed percentage of portfolio’s value at the end of the preceding yearend. The portfolio never depletes, but depending on the withdrawal rate, there can be serious shortages of income throughout retirement. This strategy is suitable for discretionary expenses only.
Example: A retiree has $100,000 at age 65 with 50%/50% asset mix. He needs $4,000/year indexed to CPI for the rest of his life. He decides that his withdrawals should never exceed 5% of the portfolio’s value. Here is the aftcast:
Here is his income carpet:
Mathematically, as long as withdrawals are less than 100% of the portfolio’s value, the portfolio never runs out of money. Therefore, with this strategy there is no SWR.
Other Equity Indices
We also calculated the sustainable withdrawal rates for a few other equity markets. Keep in mind that in these calculations:
- We ignored any impact of exchange rates,
- The interest and inflation rates are U.S. historical data for all portfolios
Therefore, they are only for comparison purposes to show the range of outcomes, and not for retirement income planning in these other countries.
Retirement Age: | SWR for ESSENTIAL Expenses (Optimum Equity/Fixed Income) | ||||
---|---|---|---|---|---|
Canada (SP/TSX) | USA (S&P500) | Britain (FTSE AllShr) | Japan (Nikkei225) | Australia (ASX AllOrd) | |
60 | 3.03% (55/45) | 2.89% (60/40) | 2.63% (45/55) | 3.34% (30/70) | 3.00% (70/30) |
65 | 3.31% (55/45) | 3.11% (60/40) | 2.86% (45/55) | 3.71% (30/70) | 3.23% (70/30) |
70 | 3.68% (55/45) | 3.42% (50/50) | 3.27% (45/55) | 3.80% (30/70) | 3.62% (70/30) |
75 | 4.29% (55/45) | 3.98% (30/70) | 3.89% (30/70) | 4.39% (30/70) | 4.23% (70/30) |
Retirement Age: | SWR for BASIC Expenses (Optimum Equity/Fixed Income) | ||||
---|---|---|---|---|---|
Canada | USA | Britain | Japan | Australia | |
60 | 3.67% (60/40) | 3.51% (30/70) | 3.01% (35/65) | 3.91% (40/60) | 3.60% (60/40) |
65 | 4.01% (60/40) | 3.91% (30/70) | 3.40% (35/65) | 4.43% (40/60) | 3.88% (60/40) |
70 | 4.51% (60/40) | 4.37% (30/70) | 3.92% (35/65) | 4.69% (40/60) | 4.53% (45/55) |
75 | 5.31% (60/40) | 5.04% (30/70) | 4.63% (30/70) | 5.15% (35/65) | 5.24% (45/55) |
Retirement Age: | SWR for DISCRETIONARY Expenses (Optimum Equity/Fixed Income) | ||||
---|---|---|---|---|---|
Canada | USA | Britain | Japan | Australia | |
60 | 4.48% (70/30) | 4.13% (30/70) | 4.16% (35/65) | 6.23% (70/30) | 4.48% (70/30) |
65 | 5.13% (70/30) | 4.59% (30/70) | 4.82% (30/70) | 6.18% (70/30) | 4.92% (70/30) |
70 | 5.93% (65/35) | 5.17% (30/70) | 5.73% (30/70) | 6.59% (55/45) | 5.69% (70/30) |
75 | 7.07% (55/45) | 6.25% (30/70) | 6.73% (30/70) | 7.69% (45/55) | 6.77% (70/30) |
Conclusion
When it comes to retirement income planning, there are no magic bullets, holy grails, smart-glide paths, genius asset allocation schemes or client-friendly adaptive withdrawal techniques. Market history shows that they just don’t exist. Be smart and follow the KISS principle: keep it simple, stupid.
While you cannot work miracles, there is a lot you can do for your clients—but only if they follow your advice. Go over the step-by-step action plan in the “Purpose Driven Sustainable Withdrawal Rate” course. It will help you figure out if the client has sufficient assets. If not, suggest delaying retirement, working part-time during retirement, trimming expenses (starting with the discretionary expense category), downsizing home, renting the basement, and so on.
Do not ignore life annuities: they certainly deserve more respect than they presently receive. Be aware that no amount of asset allocation and diversification can convert a client from the red zone to the green zone unless he or she gets very lucky.
Now that you’ve finished reading, complete the exam to receive your CE credits. If your score is 85% or higher for both Part 1 and Part 2, send an e-mail to jim@retirementoptimizer.com with your name and proof of your scores (a screen shot will do) to get a free retirement calculator based on aftcasting, and a free, read-only pdf copy of Jim Otar’s 525-page book, Unveiling the Retirement Myth.
Next steps
- Take this testLog in and answer a multiple-choice exam about the material.
- A CE Certificate will be issued electronically through the website after you pass the exam with a score of 65% or greater.
- Accreditation details
- More CE courses