# Safe Withdrawal Rates for Aussies — Part 6: Final Portfolio Balance

Posted by Dan Montgomery on 7 January 2019 in Safe Withdrawal Rate Series

After a short Christmas and New Year’s break, we’re back into safe withdrawal rates!

All the work that we have conducted so far has defined a successful retirement portfolio as a portfolio that has does not run out of money during retirement. So we calculated the safe withdrawal rate that would completely deplete the portfolio at the last day of retirement.

But, practically speaking, this would be a scary ride for many retirees. There would be a number of close calls in which the portfolio balance fell very close to zero but did not technically fail. In these cases, it’s not hard to imagine that a retiree would do something drastic, like an undignified return to work in their 70s or 80s.

Should that portfolio be considered safe? It may not have run out of money but it wasn’t a comfortable ride into retirement. A cushion would be nice.

Moreover, I’d guess that many retirees don’t want to end retirement with very little money. Surely most people want to bequest something to their family or favourite charity.

It seems that we could make a fair argument that most people want some balance left in their portfolio at the end of retirement. So in this article we examine the effect of the target final portfolio balance 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)
- Part 9: The Online SWR Calculator

## How did we get here?

We’ve learnt so much about safe withdrawal rates over the past couple of months.

First, we learnt how to calculate safe withdrawal rates and looked into portfolios made up of only Australian equities and bonds. We discovered that an optimal domestic portfolio can sustain good portfolio success rates with 75% equities or more. In fact, including some bonds (~25%) in the portfolio improved success rates over a purely Australian equities portfolio. This was our first indication that diversification is important.

We then decided to dive deeper into diversification and calculate the optimal portfolio of Australian and U.S. equities and bonds. We found that diversifying across Australian and U.S. equities was optimal, and we simply add U.S. bonds commensurate with our risk appetite. This would lower our portfolio risk — but also our return. This is shown in the image below.

After that, we wondered whether the portfolio would last longer retirement lengths. We found that portfolios could survive a 60 year retirement, so long as the asset allocation is both high in equities and diversified across Australian and U.S. equities.

## How does the final portfolio balance effect SWRs?

### Background on the calculations

Before we start calculating the effect of final portfolio balance on safe withdrawal rates 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 final balance of 0%, 50% and 100% of the starting portfolio balance. 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

### Final portfolio balance and safe withdrawal rates

The chart below plots safe withdrawal rates over time for a 30 year portfolio of 50% Australian equities, 50% U.S. equities. The three lines on the chart represent the safe withdrawal rate for a final balance of 0% of the initial balance, 50% of the initial balance and 100% of the initial balance.

Increasing the final portfolio balance can have a significant impact on the safe withdrawal rate. For a 30 year portfolio, increasing the final balance by 1% will reduce the safe withdrawal rate by 0.01%. This doesn’t seem like much, until you decide that you want your final portfolio balance to be the 100% of you initial balance and thus reduce your safe withdrawal rate by 1.06%!

In the chart below we plotted safe withdrawal rates over time for the same portfolio but for a 60 year retirement length. You can immediately see that the lines are the chart are less spread apart, implying that changing the final portfolio balance has less of an effect on safe withdrawal rates for a longer retirement length.

In fact, for a 60 year portfolio, increasing the final portfolio balance by 1% will reduce the safe withdrawal rate by 0.001% (that’s an extra zero!). This means that increasing the final portfolio balance from 0% of the initial balance to 100% of the initial balance only reduces your safe withdrawal rate by 0.15%.

These trends are consistent with what Big ERN found for U.S. portfolios. The only difference is that larger final balances reduce our safe withdrawal rates reduce by a smaller quantum because we benefit from diversification across U.S. and Australian equities.

### Final portfolio balance and 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 table below compares the effect of increasing final portfolio value on portfolio success rates for different portfolio allocations, withdrawal rates, and retirement lengths.

Here are some key observations from the table above:

- Increasing the final portfolio balance has a bigger impact on 30 year portfolios than 60 year portfolios. This is the same trend we saw in the two charts above. This might feel counter-intuitive but can be explained quite easily. A portfolio might have 90% of the initial balance after 30 years (and thus failed the 100% final balance rule) but over the next 30 years returns were high enough to get back to 100%.
- Portfolios with equity weightings below 80% were affected more by a higher final portfolio balance. To continue the example above, if a portfolio has 90% of initial balance after 30 years, it needs a high equity allocation to make up the lost ground get back to 100%. Too much bonds means returns are too low.
- Equities diversification helps tremendously in preserving portfolio success rates. The 100% Australian equities and 100% U.S. equities portfolios performed significantly more poorly than the 50% Australian/50% U.S. equities portfolio for higher final portfolio balances.
- A 50% Australian/50% U.S. equities portfolio can maintain quite high portfolio success rates for long retirement lengths and large final retirement balances even at withdrawal rates of 3.75-4.00%.

## Wrapping it up

On that last point, I don’t know that I would comfortably recommend a 4.00% withdrawal rate for retirees with a diversified equities portfolio. Remember that we are using historical simulations to infer future results — it’s not a perfect science. Call me conservative, but I’d feel more comfortable with a withdrawal rate of 3.50-3.75%.

It feels as though we’ve tackled the most common fundamental questions on this topic: domestic Australian portfolio SWRs, internationally diversified portfolio SWRs, long retirement length SWRs, and now capital preservation SWRs.

We’ve touched on it before but the main cause of portfolio failure is sequence of return risk. And asset allocation, retirement length, and target portfolio balance all change the dynamics of sequence of returns. So in the next post we’ll dive deeper into sequence of return risk to understand what it is and why it matters.

As always, if you have any questions, comments or feedback, please email me or comment below. I’d love to hear your thoughts.

## flatfire

January 7, 2019 at 6:12 am

It seems to me that going for a *guarantee* of having 50% or 100% left over is not worth it, even if the change in SWR is tiny. It is planning for the worst case scenario when in the other 95% of cases you are going to have oodles of money left over. Better to just take that risk and if it eventuates, “you’re on your own, grandkids!”

As for the “harrowing” scenario of almost running out of money at end of life, I can buy lentils with the pension money, and if the pension is gone by the time I get there… see you at the Ättestupa.

## Dan Montgomery

January 9, 2019 at 2:00 am

Haha, that video is hilarious!

## The FI Explorer

January 8, 2019 at 12:34 am

Thank you for this, Dan, this is excellent and fascinating analysis.

As I just reset my asset allocation to 75% diversified equities, the sea of green is also some comfort, though as you say, it is linked to past returns history. This is as good analysis as I’ve ever seen on this topic in Australia. The relationships between the numbers are really quite interesting to see laid out clearly like this.

I’d be interested in your upcoming thoughts on sequencing risk, and the trade-offs of seeking to manage it. That’s on my mind as well, as I am upping my target equity allocation even as my FI destination is only a 2-4 years away. That’s a decision that takes into account some work income, and human capital considerations though.

## Dan Montgomery

January 9, 2019 at 2:03 am

Congratulations at getting so close to retirement! I recommend you read more about bond tents (also known as equity glide paths), which helps reduce sequence of return risk. Here’s my two favourite explanations:

https://www.kitces.com/blog/managing-portfolio-size-effect-with-bond-tent-in-retirement-red-zone/

https://earlyretirementnow.com/2017/09/13/the-ultimate-guide-to-safe-withdrawal-rates-part-19-equity-glidepaths/

## Chris

January 8, 2019 at 9:44 pm

Hi Dan, awesome work. I’d be very interested to see which start months failed for a 50/50 diversified equity portfolio for the three scenarios. Would you mind sharing this data?

## Dan Montgomery

January 9, 2019 at 2:06 am

You can actually see some of this in the two charts above. These charts show SWR over time for the 50/50 diversified equity portfolio. Pick your SWR and then look at where the lines drop below that number in the charts. That’s where it failed. Let me know if that doesn’t make sense 🙂

## Chris

January 9, 2019 at 8:23 am

Ah, I see now – was focused on the tables not the graphs on my tiny phone screen :-). Just one question if I may – how do you calculate the SWR on historical data for a 30 year retirement from a starting year of say 2012 when you don’t have 30 years of data? Is it the case that today the most recent year you can calculate a SWR for a 30 year retirement is 1988, and everything after that is subject to change? Or have I misunderstood the analytical approach entirely? (Sorry I’ve not read the SWR references in part 3 so I’ll admit I’m clueless!)

## Dan Montgomery

February 5, 2019 at 2:15 am

Apologies Chris, I didn’t see this comment! I’ve replicated the approach that Big ERN took and assumed a low return environment in the next decade and moderate thereafter. As there is no variability in these forecasts, it probably overstates SWR slightly. I plan on updating the model with more recent data as often as I can.

You can read about the approach here: https://earlyretirementnow.com/2017/06/07/the-ultimate-guide-to-safe-withdrawal-rates-part-16-early-retirement-in-a-low-return-world/

## James

July 5, 2019 at 1:22 pm

Very interesting read! I’m now wondering how we can use this information to construct an ideal real-word portfolio.

A good candidate seems like a 50:50 split between Vanguard’s VAS and VGS funds. VDHG seems like an even simpler option that adheres pretty closely to the optional portfolio described here. Thoughts?