Market Risk and the "4% Solution"
The next thing that was done was to decide what methodology to use to evaluate risk and the requirement for mid-course corrections. As I said previously, it was not clear to me how the following should be handled (Ill be starting with the assumption that there is no fixed annuity in the equation).
Even assuming no inflation in the first year, another $44,000 withdrawal is 5.8% of the remaining portfolio. Granted the analysis done says that there has never before been a combination of years where this would have presented a problem. But I was very uncomfortable with the concept of withdrawing 5.8% under these circumstances. So the question is what is the probability of this happening, what is the correct withdrawal strategy for handling this, and how does this impact the planned income stream?
Again, for reasons of consistency with previous studies, I stayed with a 30 year time horizon. I also decided that the proper strategy was to limit the annual withdrawal to be the smaller amount of:
After thinking about this for a while I modified the second limit to recognize that shorter timeframes should be able to accommodate more aggressive withdrawal percentages. So I modified #2 to linearly scale the percentage from the initial withdrawal percentage in the first year to 7% in the 30th (final) year. I started the analysis with an initial withdrawal amount of 4.4% based on earlier analysis. The choice of 7% was basically arbitrary and I have not yet done any further analysis to try to optimize this choice. Note that I did NOT assume that your withdrawals would increase in those cases where your portfolio value grows faster than inflation.
In these terms the withdrawal rules for the Jarrett/Trinity studies were the smaller of:
Presenting the results of this analysis is more complex than the previous cases. I decided to analyze this situation by looking at the following data for each of the 54 different retirement starting years. The starting conditions were a $1,000,000 initial portfolio value and initial withdrawal of $44,000.
In this chapter the data is presented for one initial withdrawal target (4.4%).
I ended up drawing the following conclusions.