In part 3 of our Safe Withdrawal Rate Series we set out to determine the optimal mix of Australian equities and Australian bonds that would allow us to withdraw the most from our retirement portfolios without running out of money.
We found that we could safely withdraw 4.00% of our retirement balance per year (adjusted for inflation) as long as the portfolios had at least 75% Australian equities.
We also noticed that portfolios with 75% equities and 25% bonds actually performed better than a 100% equities portfolio. This was our first indication that diversification can be beneficial, even if we diversify into a lower return asset.
Then in part 4 of the series, we extended our analysis to determine whether international exposure would be better for Australian retirees. We found that we can safely withdraw more when Aussie retirement portfolios were made up of Australian equities, U.S. equities and U.S. bonds. We don’t even need to buy Australian bonds!
One conscious limitation of all that previous analysis is that we assumed a 30 year retirement length. However, in reality many early retirees may be retired for 40, 50 or even 60 years. So in this article we will examine the effect of longer retirement lengths on safe withdrawal rates.
Interested in safe withdrawal rates and want to dive into the detail? You can check out the entire series here:
- Part 1: Introduction to Safe Withdrawal Rates
- Part 2: Building and Validating a Data Set
- Part 3: Initial Findings (Domestic Equities and Bonds)
- Part 4: Portfolio Optimisation (International and Domestic Equities and Bonds)
- Part 5: Extending Retirement Length
- Part 6: Targeting a Larger Final Portfolio Balance
- Part 7: Sequence of Returns Risk and Safe Withdrawal Rates
- Part 8: Summary (So Far)
The elegant asset mix for Aussies
Before we get into the analysis on safe withdrawal rates for longer retirement lengths, some comments on the asset mix that we uncovered in the last post.
It’s actually quite elegant.
As we explained, an Australian retiree’s portfolio should include some proportion of U.S. bonds. The amount of U.S. bonds will be determined by our risk tolerance, more U.S. bonds equals lower risk. Then the remainder of the portfolio should split between Australian and U.S. equities. This will give us the best return for your risk appetite.
Just note that the asset mixes in the above chart are simplified/rounded slightly. For example, in a perfectly optimised portfolio the equity split tends to be 1-4% more heavily weighted to Aussie equities and sometimes it includes 1-2% Australian bonds. You can check out the exact asset mix here.
But, practically speaking, we can accept that an optimised portfolio should look broadly like the asset mix in the chart above. So in the interest of simplicity, we will calculate using portfolios with these simplified asset mixes. This doesn’t change the outcome significantly — but makes the calculation much easier to follow.
How does retirement length affect SWRs?
Anyway, let’s get into the meat and potatoes. Calculating the effect of retirement length on safe withdrawal rates…
Background on the calculations
Before we start calculating we should run through a little house keeping:
- We are using our data set of Australian equities, Australian bonds, U.S. equities and U.S. bonds for 1770 months from 1871 to 2018
- For each monthly starting point we calculate the exact withdrawal rate that will result in a $0 balance at the end of the retirement period. We calculate using the approach that we outlined in Part 3 of this series
- All of our calculations are adjusted for inflation (i.e. real dollars) and are net of foreign exchange movements
The relationship between retirement length and safe withdrawal rates
The chart below compares 30 year retirement length and 60 year retirement length safe withdrawal rates from 1871 to 2018 for a portfolio made up of 50% Australian equities and 50% U.S. equities.
As you can see, increasing the retirement length reduces safe withdrawal rates by about ~1%. So we would expect there to be higher failure rates for longer retirement lengths.
However, although we know what trend to expect, there are still a number of outstanding questions, such as:
- How much do longer retirement lengths increase portfolio failure rates?
- Does asset mix change the relationship between retirement length and safe withdrawal rates?
- Does increasing retirement length reduce safe withdrawal rates in a linear manner?
The effect of retirement length on portfolio success rates
As always, to understand what safe withdrawal rates mean in practical terms, we convert them into success rates. It works like this: if a withdrawal rate of 4.00% has a success rate of 95%, this means that we would have run out of money during retirement in only 88 of 1770 monthly starting points.
The huuuuge table below outlines the success rates for various portfolio allocations, withdrawal rates and retirement lengths.
There’s quite a lot to digest there, so here are some interesting findings:
- We replicated the findings from the previous post in this series that showed equity portfolios split 50/50 between Aussie and U.S. equities perform better than either 100% Aussie or 100% U.S. equities alone
- We can maintain great success rates for high equity portfolios over a 60 year retirement length when we diversify across Aussie and U.S. equities. And this is the case for withdrawal rates as high as 4.25%!
- High equity portfolios that are not diversified across countries will not always survive longer retirement. For example, if we choose to invest in 100% Aussie equities, then we need to reduce withdrawal rate to 3.75% or 3.50% to last 60 years
Visualising longer retirement lengths
The chart below plots portfolio success rates for a 50% Aussie equities, 50% U.S. equities portfolio of different retirement lengths. It’s essentially some of the same information in the table but presented in a visual format.
As we know, increasing withdrawal rate results in a drop in portfolio success rate and this happens faster for longer retirement lengths. And as we can see below, there relationship is non-linear. In other words, as safe withdrawal rates increase, portfolio success rates drop at an accelerating rate.
If we wanted to, we could build the same chart for different portfolio mixes — but it would be showing the same trend, so let’s leave it for now.
What did we learn and what are the caveats?
Before running this analysis, my hypothesis was that we’d see portfolio success rate fall quite significantly for all portfolio asset mixes when retirement length increases to 60 years. And we did see success rates fall for portfolios with 100% Aussie equities or 100% U.S. equities.
But portfolios with a high equity allocation that was split 50/50 between Aussie and U.S. equities maintained persistently high success rates. So it seems that high equity allocation and international diversification put together helps maintain acceptance portfolio success rates.
That’s great news!
However, we must keep in mind that we have defined portfolio success as the portfolio having at least $1 at the end of retirement. As one reader mentioned, most retirees don’t think this way. It’s quite risky and there’s not much room for error. Would people be able to watch their portfolio fall close to zero and not react? It would be a scary ride!
In reality, most people will want to end retirement with money left in their portfolios. So in the next post we will look at how the target balance at the end of retirement effects safe withdrawal rates.
As always, if you have any questions, comments or feedback, please email me or comment below. I’d love to hear your thoughts.