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Why Morningstar Say the Safe Withdrawal Rate is Lower than 4% in the Future

2 days ago, I got pinged by a few different groups of people regarding a retirement income study that Morningstar did.

You might have seen headlines like this:

And this:

I don’t think this is the first time someone say the 4% retirement rule is outdated, so I was surprised this gets round.

Turns out, both pieces were well written.

But I think you should read Christine and John’s write-up over at Morningstar to get the full picture. They provided more detail explanations.

But even their piece may missed out on a few things they wrote in the paper. The paper is written in a less academic or scholarly manner and it is easy to digest.

I have a lot of respect to Chistine, Jeff and John’s writings in Morningstar over the years. Christine and Jeff host the very popular The Long View podcast, which invites fund managers, retirement and finance experts to talk about various topics.

The paper discuss whether the 4% withdrawal rate is still valid, and they went into their own research, as well as project what can be a more approriate withdrawal rate.

They then humanize the research by linking to the financial planning element.

In this article, I will go through their work on past high and low withdrawal rate and what should be the ideal withdrawal rate to use.

Some of you may wonder: Why is this withdrawal rate so important?

Withdrawal rate is the amount of income you withdrawal from your investment portfolio. It affects how much you will need to accumulate, if you are planning to retire. Withdrawal rate is a good rule of thumb as a quick and dirty way to link how much you wish to spend in retirement with how much you need to accumulate.

I think why the withdrawal rate is so popular is because it makes planning so much easier.

So if you are curious whether you have accumulated enough, or how much you will need to accumulate for your retirement, this is one paper that should interest you.

Why is there a Withdrawal Rate Problem in the first place?

Morningstar has a few research goals but they centre on what should be the appropriate initial withdrawal rate to use, to decide how much we need to accumulate for our 30-year retirement.

More and more, the people in the US cannot depend on some sort of pension for their retirement but from their contribution to private retirement plans (such as this 401k plan).

But planning for retirement income is a vexing problem.

For many years, advisers have struggled to solve the combined problem of:

  1. How much do I need to accumulate for my retirement?
  2. What is the maximum I can spend per year so that I don’t run out of money?
  3. What should my asset allocation be in retirement?

So William Bengen tried to solve this problem in the 1990s and his research lead him to conclude that if you spend a maximum of an initial 4% of your portfolio, your portfolio will last for 25 years, in a 50% equity 50% bond portfolio.

So if I need $25,000 today, if I have accumulated $25,000/0.04 = $625,000, I will have an inflation-adjusted income that can last for 25 years despite deflation, inflation, boom and bust.

I do urge folks to read Bengen’s original article here because… from my experience, many financial thought leaders are rather confused about exactly how it works.

Morningstar believes that helping retirees determine the “right” withdrawal rate is one of the trickiest jobs in financial planning:

  1. The duration of retirement spending is unknowable (few years versus 30 or more years)
  2. Impossible to know in advance the specific market environment that you will experience in your lifetime
  3. Our spending pattern. Research points to a large degree in variability in spending through retirement.
  4. Inflation is a big unknown and a critical component. Inflation can be highly personal as well.

This should give us a prelude to what we are going to discuss. If we break up the Ibbotson equity and bond return data into two time periods, 1960 to 1989 remains one tough period.

The bond returns are very different from what we experience today. And some folks seem to think we stand a good chance of returning to that period.

What History Says about Safe Withdrawal Rates

Morningstar decides to crunch the data themselves, both from the academic side and also from the financial planning side.

A round of withdrawal rates was computed in a different context.

The assumptions used

Assumptions are important in that their withdrawal rate calculation may be very different from how other researchers did it.

They use a total return approach and not some dividend income model. The dividend is assumed to be reinvested. Rather than plan for a long retirement, they plan for a period based on the life expectancy of a 65-year old couple. So the time horizon is 30 years.

For those who are planning for a longer period, this usually means the withdrawal rate that you are looking for needs to be less than what was analyzed.

This part is important. To be honest, it doesn’t explain things very clearly.

They show how the income is spent in a constant-inflation method. The income is inflation adjusted based on a constant-inflation rate. This inflation rate may differ. For example, in 1990 to 2019, the inflation is different from 1970 to 1999. But they assume that between 1990 to 2019, the inflation is a constant x% and from 1970 to 1999 its a constant y%.

This is different from other withdrawal rate studies. In other studies, prevailing inflation rates are used. So they factor in a 30-year period where the inflation rate is 5.5% (like in the high inflation 1970s) and this one may not.

This is as important. Other withdrawal rate studies use historical 30-year periods. For example, they will iterate from Jan 1928 to Dec 1957 as one 30-year period, then Feb 1928 to Jan 1958. What you will have are different compounded returns, different inflation rates interacting in a unique way.

Bengen’s 4% withdrawal rate is like the maximum you can spend in the worst 25-year sequence and the money will last.

This one uses a 90% success rate, which means that the most pessimistic 30-year is not the worst 30-year period. There can be periods where the money does not last as well.

Basically, they are using US data. And we all know that the US has been a powerhouse in the past 100 years. If your portfolio does not have a big proportion in US, I feel this research would start looking less appealing to you.

Overall, I am starting to not like this research but I can understand what they are trying to do. It is that at this point, there is some part of the research that I am less clear about.

Highest and Lowest Starting Safe Withdrawal Rates, by Asset Allocation

Here is the first tabulation of safe withdrawal rates based on asset allocation:

If you ask me, I cannot make out how they derive the 13 rolling 30-year time horizon. No matter how I tried, I cannot figure out how they spaced out that 30-year.

Anyway, for different US portfolio allocations, we observe different initial withdrawal rates. If you put your money in the mattress, if you need $25,000 a year, you will need 25,000/0.014 = $1.78 million.

Notice that the highest withdrawal rate tend to increase as the equity allocation increase. BUT it doesn’t mean that if you have more equity (100% stocks), the lowest rate is the highest (the reason is volatility and you can read this article here).

This is quite consistent with other research that shows that 50% to 75% of stocks is the most ideal.

The team makes a couple of conclusions:

Some good points are that after 1955, other asset classes become available.

Equities make the portfolio volatile but they also adjust more quickly to inflation.

The team also make sure to highlight that the main reason safe withdrawal rates are unstable is not due to recession but due to changing inflation.

Highest and Lowest Starting Safe Withdrawal Rates by time Period and Aset Allocation

Now we are able to see which 13 rolling 30-year periods they are talking about! Within each, most likely they do 1000 Monte Carlo individually.

You can draw some conclusions.

There is so much uncertainty in the future but also in the past. While the future may be different, most likely, a lot of these historical sequences would apply to us.

The period with the lowest initial withdrawal rate is not the challenging 1930 to 1959 period which includes the depression and World War 2.

It is those periods involving high inflation in the 1960s and 1970s.

This is based on 90% success, which means if you want 100% success it can be even lower.

In some of my articles, I talked about that if your safe withdrawal rate is 2.8% and below, your wealth should be perpetual. This sort of throw a spanner at it.

Bonds and Cash is Quite Trashy in Retirement with Inflation

Cash provides a lot of comfort and safety.

If you are planning for a 30-year retirement, it is quite easy to estimate how much you can initially spend. Just take 100/30 and you get 3.33%.

You would have a 100% success rate of the income you get.

But the problem is… your income is not inflation-adjusted.

The team tries to illustrate this point by comparing the safe withdrawal rate of the mattress portfolio (cash) and a balanced portfolio.

Adjusted for inflation, the cash portfolio has 100% success compared to the 90% success rate of the balanced portfolio, but the real income that you could get is lower.

It begs the question: You have income, but if you cannot preserve your purchasing power, is that considered a success?

The team also compared a portfolio of bonds to a balanced portfolio in terms of real income. Bonds, over a long period, consistently returns less than equity.

Having equities also allow great bequest at the end of 30-years

What is a Safe Withdrawal Rate for the Future?

The data provided in the previous section are historical returns.

But what about the future?

What influences the future safe withdrawal rate?

The team listed down three factors that influence expected withdrawal rates:

  1. Bond yields today. Bond yields today have a strong correlation to future returns. And bond yields today are low.
  2. Stock valuations. Long term stock valuations have a strong correlation with how much you can withdrawal safely from the portfolio. And stock valuations today is high, which means the safe withdrawal rate will have to go down.
  3. Inflation rate. We have enjoyed low inflation rates for some time. Low inflation rates acts as a counterbalance to increase the safe withdrawal rate that we can have.

#1 and #2 brings down the safe withdrawal rate, which means you need to accumulate more. #3 when kept low counterbalanced that.

But there is that sneaky fear that we may re-live that 1960-1980 inflation period. An ongoing debate on whether inflation is transitory or not.

Here is how the Morningstar team explains it:

Projected Asset Class and Portfolio Future Returns

The tables below shows the annual return and standard deviation forecast provided by Morningstar Investment Services for the 30-year performances of each of the eight sub asset classes.

The returns are arithmetic averages, rather than geometric, which are what is commonly cited for investment performance. This is necessary due to the model used for this paper.

The inflation used is 2.21% a year.

Actually, the returns still looks quite high, versus some of the very pessimistic forecast that I have seen coming out from Research Affiliates and GMO.

And here are the withdrawal rates for different time periods, for 11 different portfolios:

Some observations:

If your time horizon is 10 years, you can take a high withdrawal rate but essentially, you are just breaking up your portfolio into 10 equal chunks.

If your time horizon is a short 20 years, the withdrawl rates look higher, despite the equity weighting.

If you need the money to last for 30 years, and your equity weight is between 30-70%, your initial withdrawal is 3.2%.

If you need the money to last for 40 years, the rates go down to 2.7%.

Here are some discussion points from the Morningstar team:

I detect that the team is trying to moderate the panic by pointing out that if your sequence is not so pessimistic, generally taking a 4% initial withdrawal rate is not so rash.

We should also not rush into a portfolio of high equity allocation.

What I need to point out is that the inflation assumption used here is 2.21% p.a. You might disagree with this and that would color how you view this research.

Conclusion for Part 1

Christine, Jeff and John rightly pointed out that retirement income planning is made more tricky due to a lot of complexity that we encountered less when we are accumulating.

The safe initial withdrawal rate that you can start with, based on historical data, is uncertain and driven by a few factors.

Markets are uncertain, inflation is uncertain, our longevity is uncertain, our spending pattern is uncertain.

If we break up history into a few different periods, we can see that there are challenging periods where the safe withdrawal rates are dramatically lower.

We can make a few conclusions:

  1. Parts of Morningstar’s safe withdrawal rate is different from how the other academics do it and readers should be aware of that.
  2. Inflation is a bigger problem then economic recession or bear markets.
  3. More equities gives a higher safe withdrawal rate.
  4. But too much equities may not mean you can enjoy a higher withdrawal rate.
  5. A balanced portfolio gives higher real income than cash or bonds
  6. Based on historical data, during periods of high inflation, the safe withdrawal rate maybe reduce to 2.4%.
  7. Future returns are estimated to be low because bond yields are low and stock market valuations are high. Inflation counterbalanced this.
  8. The future projected 30-year safe withdrawal rate is closer to 3.3%.

It feels to me that if you are looking for a longer inflation-adjusted income, you might need to go down lower than 2.7%. That is a rather demoralizing thought. As if 2.7% is not low enough.

But each of our experiences are different, if the market crashes, and you decide to retire, you might be able to retire at a higher safe withdrawal rate because market valuations are better.

After this report came out, the team over at Michael Kitces came up with an article that explains that provides some counterarguments to this research.

You can read Why High Equity Valuations May Not Lead to a Lower, Consistent, Inflation-adjusted Passive Income for You for my summary on the write-up.

Part 1 is all about a safe withdrawal rate. Part 2 will be to marry a safe withdrawal rate with the qualitative aspect of retirement income planning.

The withdrawal rate study assumes that your income needs every year stay constant, and you need to adjust for inflation. But what if you are more flexible? That will be what they address in part 2.

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Monday 15th of November 2021

Kyith, as usual, thank you for the very detailed writeup. However, it is can be a little too technical for me. Just a stupid question, the above are done based on have zero $ at the end of the period? I am wondering if my intention is not really to leave any inheritance, those the withdrawal rate change drastically?


Thursday 18th of November 2021

Hi BC, unfortunately, if we are trying to be more sure about our retirement numbers, we would need to go a little deeper. In my article, I think I linked to Bill Bengen's original article: It gives people an idea why he go about doing things this way. I know some of you don't want to leave an inheritance. The issue is... imagine there are 13 BC living through 13 different 30 year periods... one of those BC is gonna be the unlucky one. what is the maximum that BC can spend on the first year, then adjust his income for subsequent years and the money still last just nicely for 30 years?

That is roughly what the safe withdrawal rate means. In Morningstar's example, they use a 90% success.. this means that maybe 1 or 2 of those BC is not gonna have their money last, but generally using 3.3% is still conservative enough. Hope this helps.


Monday 15th of November 2021

Hi Kyith, thanks for the article.

Whenever I see your post on FB about new article, it would not be appearing on this site until after a day (or so) later. Is this done on purpose?


Thursday 18th of November 2021

Hi Pete, not actually! I posted them usually at 7-8 am in the morning of the same day!

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