47% of Baby Boomers regret not starting retirement planning earlier. 35% wish they had more cash stashed away. By age 65, the average American has only saved 30% of the $1 million they’ll need to maintain their comfortable lifestyles once they stop working.” Teresa Kuhn
What drives my devotion to the financial concept of “infinite banking” has always been the nagging feeling that conventional retirement planning is out of touch with reality. It has recently become apparent to many of us that the usual wealth and retirement strategies are not working.
I encourage clients to pay close attention to what actuarial science says about optimizing retirement. That feeling that something just isn’t right in the retirement planning world has been borne out repeatedly by economic studies that challenge what most of us believe we know about successful retirement planning. For these reasons, I often have my clients rethink putting most of their wealth into bonds.
A recent Morningstar report authored by Dr. Michael Finke, Ph.D., CFP®, Dr. Wade D. Pfau, Ph.D., CFA, and David Blanchett, CFA, CFP® examined sustainable withdrawal strategies and determined the overall impact of low yields. These researchers employed a methodology that differed from the usual Monte Carlos simulation based on long-term averages.
Instead, researchers developed what they term a “drift” model.
According to the authors, this model “considers current bond yields and allows them to “drift” toward a higher value during retirement using an autoregressive model based primarily on historical relationships between asset classes.” The study claims, “This approach can better replicate the actual bond returns a current or near retiree can expect during retirement both now and in the future.”
Using the drift model, the Morningstar researchers drew some startling conclusions:
- The research found a not insignificant reduction in safe initial withdrawal rates. For example, over 30 years, a 4% initial real withdrawal rate has approximately a 50% probability of success. (Blanchett et al.)
- A retiree with a 90% probability of achieving a retirement income goal in 30 years with a 40% equity portfolio would have an initial withdrawal rate of only 2.8%. According to the study, such a low rate would require you to save a whopping 42.9% more if you wanted to pull the same dollar value out of your portfolio annually as you’d get with a 4% withdrawal rate from a smaller portfolio. (“Executive Summary, Blanchett et al.)
- Rising bond yields, although they would result in higher returns for new bond investors, would adversely affect those who already hold bonds as the values of their low-yield bonds decline.
- While a 4% withdrawal rate has previously been considered “safe,” the study found that your rate may not be safe at all in a low-yield environment. In reality, a 4% withdrawal rate may have a 50% chance or less of success over 30 years!
The study’s authors concluded that traditional planning, emphasizing portfolios heavy in bonds, will be insufficient to meet retirees’ needs in the 21st Century.
The upshot of this and other in-depth retirement research is that bonds, often presented as the best place to put the bulk of one’s retirement money, perhaps deserve greater scrutiny. Retirees and pre-retirees may wish to examine their portfolios to see if rethinking their bond positions might be a worthwhile course of action.
If you’d like to discuss alternatives to bonds or have me provide a second set of eyes for your current plan, I would be happy to do so. Call my office today at (800) 382-0830 to schedule a session. A consultation costs you nothing; together, we can look for gaps or potential pitfalls.