New Research: The Best Retirement Withdrawal Strategies

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Many retirees will use systematic withdrawals from an investment portfolio for retirement income. I’ve done new research into the best retirement withdrawal strategies. History shows that your success can vary widely using the same portfolio and the same overall withdrawal rate, without changing your investments. It all depends on how you withdraw from different asset classes like stocks and bonds. The secret is keeping it simple and using a consistent, value-driven approach. The payoff could mean extracting millions more income from your nest egg over the course of a long retirement.

Most of us know we can’t outperform the market by actively trading stocks. Our best bet for building wealth over the long haul is to invest regularly in low-cost, broad-based index funds. Trying to time the market by actively trading has been thoroughly debunked. But how does that lesson apply in retirement, when we must choose when and how to liquidate our accumulated assets?

“Buy your straw hats in the winter.” An old Wall Street adage advises it’s best to buy assets when they are out of favor. And it’s best to sell them when they’re in favor. So, when living off assets in retirement, shouldn’t you try to sell the most valuable ones first? Wouldn’t that make your savings last longer, or allow you to spend more, or both? The answer seems obvious. But it leads to the next question: How do you choose your most valuable assets to sell?

This question has not been studied much, if at all, in the context of retirement withdrawals. So, recently, I set out to answer it. I developed a numerical model using historical market returns to analyze different withdrawal strategies for the major asset classes — stocks and bonds. Altogether, I evaluated several hundred different scenarios. The results were startling and possibly unique….

Choosing Assets to Sell in Retirement

In every study I’ve seen, assets are blindly liquidated across all available asset classes, without regard for valuations. But savvy real-world retirees are going to attempt to sell the assets most in favor. It will be one of the first thoughts to cross your mind, when you need retirement savings to cover your living expenses: Do you liquidate across all your holdings, or do you attempt to choose the optimal asset class?

That is what I’ve attempted, unscientifically, in the past:

In my 2012 post on dipping into principal, I wrote “…as I tap my holdings for retirement income, I’m doing exactly the same as I did during the accumulation years, but the equation is reversed. Instead of buying at lows – adding to assets that have done the worst, I’m selling at highs — pulling from the assets that have done the best.”

In my 2013 post on flexible withdrawals, I wrote that I “take a total return approach that might be characterized as “just in time,” or “active safe withdrawals” … when I need money, I sell some of my most appreciated assets. For me, it makes no sense to live off your conservative cash and bond buckets when stock markets are up. That’s like dipping into the storehouse when there is fresh, healthy grain available in the fields.”

Selling cyclical assets when they are up seems like a logical route to optimize returns. Thus, if you’re in the middle of a bull market, you’re going to sell stocks. And if you’re in the middle of a stock market meltdown, you’re going to sell bonds. It’s a natural and sound instinct, but one largely overlooked by research. The challenge is finding a reliable indicator. What do we mean by assets being “up”? Can we quantify that?

So far in retirement my gut instinct has been to look at recent market performance. If stocks were up the last few years, I’d sell stocks. If they were down, I’d sell bonds. I thought that would leave me ahead. But it’s not very scientific. Does an approach like that, based on recent averages or market momentum, hold up to analysis? Let’s take a look….

Six Retirement Withdrawal Strategies Evaluated

I used historical data to test a portfolio of stocks and bonds using six different possible strategies for retirement withdrawals. I started with a hypothetical $1M portfolio, split 50/50 between the S&P 500 stocks and 10-year Treasuries. And I used a traditional 4% initial withdrawal rate, meaning a $40K withdrawal in the first year, adjusted for inflation in subsequent years, over a 30-year retirement.

I used that traditional withdrawal rate and retirement length because they are a convenient baseline for comparing results. Modern retirements might be longer, and modern safe withdrawal rates might be less. But I’m not trying to prove anything here about safe withdrawal rates. I’m just trying to find if there is a way to get more in the end, if you manage to sell your highly-valued assets first.

I computed the results for each withdrawal strategy, for every possible 30-year retirement span since 1928*. That meant I tested 58 possible retirement periods for each withdrawal strategy.

The strategies themselves are each quite simple, but vary significantly in their philosophy and results. Note these are pure withdrawal strategies. They never buy or sell, or change the asset allocation, by any amount other than to generate the required withdrawal in a given year:

Equal Withdrawals Strategy — This is the simplest strategy of all. Whatever the total required withdrawal in a given year, just divide it equally and withdraw the same amount each from the current balances of stocks and bonds.

Rebalancing Strategy — This is a common approach, though implementations differ. It uses the withdrawal as the means for bringing the asset classes back to the original, target allocation — 50/50 in my model. So, if the difference between the current holding of stocks and bonds is less than the withdrawal amount, the strategy brings them back to precisely the target allocation. If not, it gets as close as possible.

The next three strategies can be thought of as relative-value or momentum-oriented approaches. They look back in time over various intervals, attempting to decide if stocks or bonds are higher-valued at the moment:

Last Year Performance Strategy — If stocks returned more last year, this strategy withdraws entirely from stocks in the current year. If bonds returned more, it withdraws from bonds.

3-Year Moving Average Strategy — If the average of stock returns for the last 3 years beat the average return from bonds over the same period, this strategy withdraws entirely from stocks. Else it withdraws from bonds.

7-Year Moving Average Strategy — If the average of stock returns for the last 7 years beat the average return from bonds over the same period, this strategy withdraws entirely from stocks. Else it withdraws from bonds.

The final strategy I tested uses one of the most widely studied and watched stock valuation indicators — Robert Shiller’s Cyclically Adjusted Price-to-Earnings ratio or CAPE. It’s defined as the price of the S&P 500 divided by the average of the last ten years earnings, adjusted for inflation*.

CAPE Median Strategy — If the CAPE is greater than its long-term median (a kind of average), then we assume that stocks are highly valued, and the strategy withdraws entirely from stocks. If the CAPE is below its long-term median, the strategy withdraws entirely from bonds*.

Results: The Best Retirement Withdrawal Strategies

For each strategy I computed the success rate — how many of the historical retirement periods ended with a portfolio balance greater than zero, and the median ending portfolio value (in future dollars). This table lists the results:

StrategySuccess Rate*Median Ending Portfolio Value
Equal Withdrawals89.7%$4,723,103
Last Year Performance86.2%$4,052,572
3-Year Moving Average77.6%$2,808,509
7-Year Moving Average74.1%$2,106,001
CAPE Median89.7%$6,771,521

Conclusion and Caveats

These numbers are remarkable. They show a difference in success rate of more than 15%, and a difference in ending portfolio value of more than $4M, based solely on how you withdraw from the major asset classes. If you follow the best strategy, it could be like getting free money in retirement.

Some caveats: I’m an engineer, not a financial academic. Though I’ve carefully checked my work, and it seems to correlate reasonably well with previous safe withdrawal rate studies, that doesn’t mean it’s correct. Before you commit real money to this or any retirement withdrawal strategy, verify it with other experts.

Also, when it comes to investing, never forget that past performance is no guarantee of future results. Though a strategy of selling assets at cyclical highs makes logical sense, and my historical simulations seem to support it, there is simply no guarantee that what worked in the past will continue to work in the future. I’ve done a probabilistic analysis of 58 scenarios for each of 6 withdrawal strategies. But there is no guarantee which, if any, of those scenarios might approximate your own real-life experience!

My Retirement Withdrawal Strategy

That said, I can tell you what I’m doing with these results. This isn’t an academic exercise for me. I am retired. I am living off my assets. I need a withdrawal strategy.

I have more confidence in historical simulations than I do in artificial Monte Carlo approaches or mere speculation about the future. Though historical simulations can’t predict future outcomes, I think they are a good way to test investing behavior. Other factors being equal, behaviors that were beneficial in the past will tend to be beneficial in the future.

These results show that the order in which you liquidate asset classes can make a substantial difference in your overall retirement income. Two withdrawal strategies stand out: Equal Withdrawals for its simplicity, and the CAPE Median for its performance. Equal Withdrawals is dead simple, and the CAPE Median isn’t much harder. To use it, when you need cash in retirement, you look up CAPE on the web. If it’s greater than the long-term median (currently about 16), you sell some stocks. If it’s less, you sell some bonds.

According to my research, if you do this consistently, you’ll come out ahead, possibly way ahead, of other withdrawal strategies. So that’s what I’ll be doing, until I learn something better.

And, if you’re skeptical or want to keep it even simpler, my research shows that, if your allocation is around 50/50, you can just sell equal amounts of your stocks and bonds each year, ignore rebalancing, and likely do very well, beating most other strategies.

The bottom line from this research is that consistency is most important. Reliably following either of my top two strategies — Equal Withdrawals or CAPE Median — will likely beat the momentum-inspired moving average strategies. And both of these top two retirement withdrawal strategies will almost surely trounce any emotion-driven attempts at market timing in retirement.

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*Data courtesy of Aswath Damodaran and Robert Shiller. Withdrawals made annually, at start of year. When one asset class could not be sustained for the full 30-year retirement, further withdrawals were made from the remaining asset class, for as long as it lasted. Values have been updated with slight corrections from my 3/2016 follow-up research. (Note Wade Pfau and Michael Kitces have also studied CAPE in retirement contexts.)

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