New Study Shows Using 4% Rule For Retirement Plans Has 57% Failure Rate In Low Interest Rate Environment

Friday, January 18, 2013 08:06
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New Study Shows Using 4% Rule For Retirement Plans Has 57% Failure Rate In Low Interest Rate Environment

Tags: Advisor businesses | retirement income | retirement planning

A new study by Michael Finke, Wade Pfau, and David Blanchett says the 4% retirement rule has a 57% of failure in a low interest rate environment.
 
The study’s authors state that advisors who use the 4% rule in designing their clients’ retirement plans are making a grave mistake.

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The study takes in the effect demographics have on asset demand as well as future return possibilities.
 
The largest cohort in history is in the early stages of retirement. Emerging countries also have higher savings rates and are becoming wealthier and wealthier.
 
These factors have yielded a capital glut that is depressing yields in the US.
 
The study’s authors say that advisors are extrapolating present realities and applying it to clients’ retirement income plans.
 
Monte Carlo simulators show only a 6% failure rate when using an inflation-adjusted 4% withdrawal rate based on historic returns. Advisors generally feel that is reasonably safe.
 
But portfolio returns during the first years of retirement have a disproportionate effect on failure rates.
 
The 4% withdrawal rule is based on average annual real returns of 2.6% for bonds and 8.6% for stocks.
 
As of January 2013, bond yields are 4% less than their historical average. If bond returns are calibrated to the January real returns offered on five-year TIPS while maintaining the historic equity premium, the failure rate jumps to 57%.
 
Advisors must consider that risk-free investments today have a negative real rate of return.
 
Even if rates go back up in five years, the failure rate only drops to 18%. That’s three times the rate based on historical returns.

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