Decision Rules and Maximum Initial Withdrawal Rates

Journal of Financial Planning: March 2006

Executive Summary

• This paper uses stochastic (Monte Carlo) analysis to test the decision rules established by co-author Jonathan Guyton (Journal of Financial Planning, October 2004), which established higher initial withdrawal rates than reported in previous research. Investment return and risk modeling are based on two different investment data periods: 1973–2004 (to match Guyton 2004) and 1928–2004.
• The paper tests three equity allocations: 50 percent, 65 percent, and 80 percent.
• The paper develops confidence standards to measure the probability of sustaining an initial withdrawal rate for at least 40 years and the percentage of purchasing power maintained during the withdrawal period.
• The paper retains the portfolio management and withdrawal rules from the original work, and eliminates the inflation rule (which caps annual inflationary adjustments).
• It develops two new decision rules—the capital preservation rule and the prosperity rule—which act as "financial guardrails" when market conditions cause the initial withdrawal rate to rise or fall significantly.
• The paper concludes that initial withdrawal rates of 5.2–5.6 percent are sustainable at the 99 percent confidence standard for portfolios containing at least 65 percent equities. The 80 percent equity allocation provides greater purchasing power maintenance at slightly lower success rates, but with 50 percent equities, maximum initial withdrawal rates drop to as low as 4.6 percent.
• The two data periods provide virtually identical results.
• Consistently applying the two new decision rules effectively eliminates the risk of exhausting retirement assets.

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