A January 21st report from Morningstar Investment Management quantifies what many retirements users have been grappling with on their own recently — how much do you need to save for retirement in the current very low interest rate/low bond yield environment.

Retirement Portfolios

According to David Blanchett, Michael Finke and Wade D. Pfau, the long-standing advice of building a portfolio big enough that withdrawing 4% per year would meet your needs for 30 years is simply not true any more. It turns out for a “safe retirement” in today’s low-interest world, you need a portfolio big enough so that taking out just 2.8% per year will meet your needs.

Retirement Portfolios

The new math for retirement portfolios

Blanchett and colleagues highlight that yields on government bonds have been significantly below historical averages for some time now. Multi-years of low bond yields will have a major impact on retirement portfolios, which tend to be heavily weighted towards bonds, because portfolio returns in the earliest years of retirement have a bigger effect on the likelihood that a retirement income strategy will succeed (last 30 years) than portfolio returns when you are actually retired (sequence risk).

Retirement Portfolios

The authors have developed a new model that takes into account current bond yields and includes a “drift” factor toward a higher value during retirement, autoregressing based mainly on historical relationships between asset classes. They argue this approach more closely models the actual bond returns a current or near retiree can anticipate now and in the future.

They explain the key conclusion of their study: “We find a retiree who wants a 90% probability of achieving a retirement income goal with a 30-year time horizon and a 40% equity portfolio would only have an initial withdrawal rate of 2.8%. Such a low withdrawal rate would require 42.9% more savings if the retiree wanted to pull the same dollar value out of the portfolio annually as he or she would get with a 4% withdrawal rate from a smaller portfolio.”

Four percent withdrawal rate means a 50/50 chance of money lasting 30 years

Retirement Portfolios

Perhaps the most scary finding of the Morningstar report is is that those who stick with the “gold standard” 4% withdrawal plan only have around a 50% of having their retirement portfolios last a full three decades.

Keep in mind that not all retirement portfolios are the same, and Blanchett et al.’s model is based on retirement portfolios that are 60% bonds and 40% equities.

Retirement Portfolios