Can Retirement Portfolios Sustain a 4.5% Withdrawal Rate?
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One of the crucial decisions we have to make as investors is the rate at which we withdraw from our portfolio in retirement. It impacts our quality of life and the longevity of the portfolio and has to be a thoughtful balance between the two of these factors.
The figure of 4.5 per cent is commonly identified as a reasonable long-term withdrawal rate, with sustainable withdrawal estimates between 4 per cent and 5 per cent being common.
This article is a test of the reasonableness of the 4.5 per cent withdrawal rate over the past 25 years and the past 15 years using real-world data – with particular interest over the past 15 years given the two significant market downturns of the Global Financial Crisis and COVID-19.
Methodology
To test the 4.5 per cent portfolio withdrawal rate in a real-world scenario, we have used:
- A portfolio made up of 30 per cent cash, 50 per cent Australian shares and 20 per cent global shares (unhedged) that capture the market average return for each asset class, and that is rebalanced annually
- Portfolio costs of 0.5 per cent per annum
- Franking credits being earned on the Australian share investments, based on a 4 per cent dividend yield and 70 per cent of the dividends being fully franked
- The portfolio starts at $1,000,000 with $45,000 annual withdrawals, with withdrawals increasing each year with inflation
- Inflation calculated by the RBA inflation calculation (which is an interesting and easy to use tool that can be found here: Inflation Calculator | RBA)
The 25-year portfolio uses calendar year data starting in 1997 and ending 31 December, 2021.
The 15-year portfolio uses calendar year data starting in 2007 and ending 31 December, 2021.
The 25-Year Experiment
The executive summary is that if you retired in 1997, maintained a portfolio similar to the one above, you will be in particularly good shape 25 years into your retirement.
The annual withdrawals, which started at $45,000, are now $80,000 per year because of inflation. However, the capital of the portfolio, which started at $1,000,000, is now valued at $2.72 million.
The biggest adjustment that you should be looking to make at this point in time is increasing the annual withdrawal to over $120,000 per year given the $80,000 annual withdrawal is very modest (based on 4.5 per cent being a reasonable withdrawal rate).
The ‘wind in the sails’ of these great returns are some very strong returns from Australian share investments in the first five years of the portfolio – returns including 11.4 per cent in 1997, 19.3 per cent in 1999 and 10.1 per cent in 2001.
The following tables details the calculations:
|
Calendar Year |
Australian Shares (%) |
Value of Franking Credits |
Global Shares (%) |
Cash (%) |
Portfolio Return 30 cash:50 Aust Shares:20 Global Shares (%) |
Annual Costs 0.5% |
Inflation (%) |
Portfolio Value |
Drawings |
End Porfolio Value |
|
1997 |
11.4 |
$6,000.00 |
41.6 |
5.6 |
15.7 |
0.5% |
2.8 |
$1,000,000 |
$45,000 |
$1,113,000 |
|
1998 |
8.5 |
$6,678.00 |
32.3 |
5.1 |
12.24 |
0.5% |
2.8 |
$1,113,000 |
$46,260 |
$1,204,084 |
|
1999 |
19.3 |
$7,224.51 |
17.2 |
5 |
14.59 |
0.5% |
2.8 |
$1,204,084 |
$47,555 |
$1,333,409 |
|
2000 |
5 |
$8,000.45 |
2.2 |
6.3 |
4.83 |
0.5% |
2.8 |
$1,333,409 |
$48,887 |
$1,350,259 |
|
2001 |
10.1 |
$8,101.55 |
-10 |
5.2 |
4.61 |
0.5% |
2.8 |
$1,350,259 |
$50,256 |
$1,363,601 |
|
2002 |
-8.1 |
$8,181.60 |
-27.4 |
4.8 |
-8.09 |
0.5% |
2.8 |
$1,363,601 |
$51,663 |
$1,202,986 |
|
2003 |
15.9 |
$7,217.92 |
-0.8 |
4.9 |
9.26 |
0.5% |
2.8 |
$1,202,986 |
$53,109 |
$1,262,476 |
|
2004 |
27.6 |
$7,574.86 |
9.9 |
5.6 |
17.46 |
0.5% |
2.8 |
$1,262,476 |
$54,596 |
$1,429,571 |
|
2005 |
21.1 |
$8,577.42 |
16.8 |
5.7 |
15.62 |
0.5% |
2.8 |
$1,429,571 |
$56,125 |
$1,598,174 |
|
2006 |
25 |
$9,589.04 |
11.5 |
6 |
16.6 |
0.5% |
2.8 |
$1,598,174 |
$57,697 |
$1,807,372 |
|
2007 |
18 |
$10,844.23 |
-2.6 |
6.7 |
10.49 |
0.5% |
2.2 |
$1,807,372 |
$58,966 |
$1,939,807 |
|
2008 |
-40.4 |
$11,638.84 |
-24.6 |
7.6 |
-22.84 |
0.5% |
2.2 |
$1,939,807 |
$60,263 |
$1,438,432 |
|
2009 |
39.6 |
$8,630.59 |
-0.3 |
3.5 |
20.79 |
0.5% |
2.2 |
$1,438,432 |
$61,589 |
$1,677,331 |
|
2010 |
3.3 |
$10,063.99 |
-2 |
4.7 |
2.66 |
0.5% |
2.2 |
$1,677,331 |
$62,944 |
$1,660,682 |
|
2011 |
-11.4 |
$9,964.09 |
-5.3 |
5 |
-5.26 |
0.5% |
2.2 |
$1,660,682 |
$64,329 |
$1,510,662 |
|
2012 |
18.8 |
$9,063.97 |
14.1 |
4 |
13.42 |
0.5% |
2.2 |
$1,510,662 |
$65,744 |
$1,649,159 |
|
2013 |
19.7 |
$9,894.96 |
48 |
2.9 |
20.32 |
0.5% |
2.2 |
$1,649,159 |
$67,190 |
$1,918,727 |
|
2014 |
5 |
$11,512.36 |
15 |
2.7 |
6.31 |
0.5% |
2.2 |
$1,918,727 |
$68,669 |
$1,973,049 |
|
2015 |
3.8 |
$11,838.29 |
11.8 |
2.3 |
4.95 |
0.5% |
2.2 |
$1,973,049 |
$70,179 |
$2,002,509 |
|
2016 |
11.6 |
$12,015.05 |
7.9 |
2.1 |
8.01 |
0.5% |
2.2 |
$2,002,509 |
$71,723 |
$2,093,189 |
|
2017 |
12.5 |
$12,559.13 |
13.4 |
1.7 |
9.44 |
0.5% |
2.2 |
$2,093,189 |
$73,301 |
$2,219,578 |
|
2018 |
-3.5 |
$13,317.47 |
1.5 |
1.9 |
-0.88 |
0.5% |
2.2 |
$2,219,578 |
$74,914 |
$2,127,352 |
|
2019 |
24.1 |
$12,764.11 |
28 |
1.5 |
18.1 |
0.5% |
2.2 |
$2,127,352 |
$76,562 |
$2,437,968 |
|
2020 |
3.6 |
$14,627.81 |
5.7 |
0.4 |
3.06 |
0.5% |
2.2 |
$2,437,968 |
$78,246 |
$2,436,762 |
|
2021 |
17.75 |
$14,620.57 |
29.84 |
0.4 |
14.963 |
0.5% |
2.2 |
$2,436,762 |
$79,968 |
$2,723,844 |
The 15-Year Experiment
The results of the 15-year experiment are not as conclusive. The portfolio started in 2007 with $1,000,000 and an initial withdrawal of $45,000. The $45,000 withdrawal increased annually with inflation and by 2021 was $61,000.
The portfolio has increased slightly in value and is now valued at $1.16 million.
The reason for the headwinds? Two particularly poor years of returns from Australian shares in the first five years of the portfolio, a negative 40.4 per cent year in 2008 and a negative 11.4 per cent year in 2011.
The question, then, is has a 4.5 per cent withdrawal rate held up over this difficult investment period which has included a historically low cash rate and the impact of both the Global Financial Crisis and COVID-19 downturns?
If we assume that the owner of the portfolio was aged 60 at the start of their retirement, they are now 75 and their capital has, in nominal terms, increased from $1 million to $1.16 million. This is not a terrible outcome, although clearly not as attractive as the case study starting retirement 10 years before them. That said, a 4.5 per cent annual withdrawal rate has been reasonable and, with some care, the portfolio is in sound shape to support the next 15 years of retirement.
The Value of Franking Credits
If we do not include the value of franking credits in the calculation, the ending balance of the 15-year portfolio falls from $1.16 million to $970,000.
The 25-year portfolio ending balance falls from $2.72 million to $2.15 million.
This suggests two things:
1/ Small changes to the rate of return of a portfolio makes significant differences to final outcomes; and
2/ The tax benefits of franking credits are an important benefit for retirees
This last statement seems particularly pertinent as franking credits are the difference between the 15-year portfolio having increased in value by about 16 per cent or fallen by about 3 per cent.
A Margin of Safety
The concept of a margin of safety is often talked about in investment and can be applied to the portfolio situation. It has been assumed that over the 15 and 25 years that portfolio withdrawals have been constant, however it is very easy to reduce these withdrawals in the face of a period of poor investment returns. This will improve portfolio outcomes.
Another margin of safety can be built into a financial situation through the use of an additional sum of cash, set aside as the portfolio is established, that can be used to purchase assets as markets fall – taking advantage of market downturns as a buyer, and improving subsequent portfolio returns as markets recover.
Conclusion
A real-life test of a 4.5 per cent withdrawal rate, across a portfolio that is 30 per cent cash, 50 per cent Australian shares and 20 per cent global shares shows that for a retiree who began their retirement 25 years ago in 2007 has had a positive experience – indeed so positive that it is time that they thought about spending more money on the back of a strong portfolio performance.
A person who retired 15 years ago has had a slightly less positive experience, with their portfolio increasing slightly in value over this time although they are still in a reasonable position to keep meeting portfolio drawings.
Note: This article was originally published in the Eureka Report in February 2022 - if you would like to see more of these article please here to subscribe
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