New retirees might enter a different environment from their predecessors—the economy or market might have changed slightly or dramatically.
Morningstar researchers have identified a new starting safe withdrawal rate. Hint: it’s slightly lower than last year.
Here to discuss this research is Amy Arnott, a portfolio strategist with Morningstar. The interview has been edited for length and clarity.
This is one of the most difficult questions that people will face during their financial lives. When you’re saving for retirement, it’s pretty straightforward as long as you start early and you’re consistent. But when it comes to your retirement portfolio and figuring out how to turn it into a paycheck for yourself, that gets more complicated.
There’s the danger of running out of money during retirement, but on the other hand, a lot of people actually end up underspending. So, there’s a balance between spending enough that you can enjoy your retirement, but not spending so aggressively that you might have to cut back later in life.
Most retirement withdrawal research is based on looking at historical market data. This started with William Bengen’s landmark paper in 1994, which looked at market data going back to 1926 and figured out the highest withdrawal rate you could have made that would’ve survived. That’s the origin of the 4 percent rule.
But we decided that instead of looking at past data, we would do something more forward-looking, using market estimates for possible future returns.
It assumes that you take a certain withdrawal rate, say 4 percent, and apply that to your starting portfolio balance. That becomes your first-year portfolio withdrawal. Each year after that, you adjust the amount for inflation. So you’re basically keeping a steady spending amount and never changing it.
The reason it’s conservative is that we’re looking for a very high probability of success. We’re also looking for a very long time horizon, assuming a 30-year retirement period.
And finally, we’re using conservative estimates for market returns. So we build in a buffer so that we’re not assuming the best-case scenario, but also there’s a bit of a cushion built into the numbers in case things don’t go as well as expected.
So we now have a situation where valuations are relatively high on stocks, which leads to the possibility that maybe future returns could be lower.
So, we reduced our return assumptions for stocks and across different sub asset classes and then also on the bond side. Since we had three rate cuts in 2024, bond yields are lower, which again suggests that future returns are probably also going to be a bit lower.
