The John C. Bogle Center for Financial Literacy is pleased to sponsor the 37th Bogleheads Live with Christine Benz.
Christine answers your questions about sustainable spending in retirement
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Thank you for joining us for the 37th Bogleheads® Live, where the do-it-yourself investor community asks questions to financial experts live.
My name is Jon Luskin, and I'm your host. Our guest today is Christine Benz, returning for her second appearance on Bogleheads® Live. Christine originally joined us for Episode #5 where we discussed asset correlations and sustainable distributions in retirement. I'll link to that in the show notes for our podcast listeners.
Let's start by talking about the Bogleheads®, a community of investors who believe in keeping it simple, following a small number of tried-and-true investing principles.
This episode of Bogleheads® Live, as with all episodes, is brought to you by the John C. Bogle Center for Financial Literacy, a 501(c)(3) nonprofit organization dedicated to helping people make better financial decisions. Visit boglecenter.net to find valuable information and to make a tax-deductible donation.
Before we get started on today's show, some announcements: for our next Bogleheads® Live, Diane Gaswirth joins us to answer your questions about Medicare. That'll be Thursday, February 2nd, 11:00 AM Pacific, 2:00 PM Eastern. You can see the full list of future guests at bogleheads.org/blog/bogleheads-live.
Also, if you haven't already checked them out, videos from the 2022 Bogleheads® Conference are now available online. If you weren't able to attend our annual event, check out boglecenter.net/2022conference to see what you missed.
Before we get started on today's show, a disclaimer: this is for informational and entertainment purposes only, and should not be relied upon as a basis for investment, tax or other financial planning decisions.
Let's get started on today's show with Christine Benz. Christine Benz is Morningstar's Director of Personal Finance and author of “30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances” and the author of “The Morningstar Guide to Mutual Funds: Five Star Strategies for Success.”
Christine Benz, thank you for joining us once again on Bogleheads® Live. Let's talk about your new research. Tell us about how much retirees can expect to spend in retirement now.
Christine Benz: This is a piece of research that we put out in December of 2022. It's a reissue of something that we worked on in 2021, but we updated it with our Morningstar investment management team’s view of the forward-looking return prospects for stocks and bonds and inflation.
So for people who are following last year's research, you may have seen that we made a headline with our finding that people who are using kind of a fixed real withdrawal system, if you're taking out X% in year one of retirement and then inflation adjusting that dollar amount thereafter, our finding was that if you have a 30-year time horizon and you're using a balanced portfolio and you're aiming for a 90% success rate, in 2021 the finding was that you should probably stick with a 3.3% starting withdrawal if you wanted a 90% chance of not outliving your funds over that 30-year horizon.
Thanks to the fact that stocks have dropped - so equity valuations are lower, returns have dropped as well thanks to rising interest rates, and yields are higher - thanks to the confluence of those events, we think that retirees who are embarking on retirement in say late 2022 or early 2023 can use a higher percentage.
So we came out with a 3.8% safe spending rate, again using the same base case assumptions. So, assuming a balanced portfolio, assuming that 30-year time horizon and that 90% probability of not running out of funds.
Jon Luskin: Looks like we got username triple digit golfer’s question answered. What is the estimated safe withdrawal rate for that 60/40 portfolio? 3.8%.
Christine, one thing I think about is that even with this higher rate of 3.8%, it's still less than what historical results have suggested. And I can't help but think what that could mean is that historically the returns we've seen have been irregular. The market in the past provided a sustainable distribution rate at 4% or maybe even 4.7% if you add micro caps, but we may not be able to get that in the future going forward.
Christine Benz: It's really important to distinguish our research from, say, Bill Bengen's seminal research on the 4% guideline. His research looked over market history to determine what would have been a safe withdrawal amount, even if you retired into the worst market environment in market history, which turns out to have been sort of the 1960s, early 1970s. Even if you hit that exactly wrong, his research found that retirees generally could take out 4% even in the worst periods.
Jon Luskin: You can check out Episode #35 of Bogleheads® Live, where I interview Bill Bengen, creator of the 4% rule of thumb. I'll link to that in the show notes for our podcast listeners.
Christine Benz: Our research is a little bit different in that we aim to be forward-looking. So, we're not using historical returns, we're actually using our own Morningstar investment management team’s capital markets assumptions for the next 30 years. We're plugging those in and then running Monte Carlo simulations.
So, while last year's report on this topic did have a long discussion of what history tells us, we do think that incorporating current valuations, current bond yields is important if you want to be realistic about safe withdrawal rates going forward.
Jon Luskin: Thomas, go ahead.
Thomas Speaker 1: Christine, a quick question about when we think about a 30-year horizon how that timeframe would overlap RMDs, especially if under the new RMD tables, because it seems like the RMD amount would drive the withdrawal rate to a higher level, starting probably above 4% at 75.
Christine Benz: Great question there. Key thing is they're called Required Minimum Distributions, not Required Minimum Spending. So, if you're looking at your RMDs or your planned RMDs and they're going to lift you over what you think is a safe spending rate, you can and should reinvest those distributions back into your portfolio.
So, if you have earned income, you can possibly even get them back into an IRA. But for many people who are over 72 or 73, they don't have earned income. So, the option there would be to reinvest into some sort of a taxable brokerage account.
So, super important question, but it's also important to note that older adults do have shorter time horizons. It's just a fact of life. And so, if you are, for example, an 80-year-old retiree, you should not be assuming a 30-year time horizon. That would force you into withdrawals that are probably much too conservative if your goal is to have the best standard of living that you can have during your own retirement years.
One thing we see as we look at retirement withdrawal rates - safe withdrawal rates over shorter time horizons - is that older adults can indeed take more because they're spending horizon is shorter. Of course, older adults may have reasons to want to preserve their assets, especially for heirs or for charity. But older adults who do want to consume as fully as they possibly can, can and should take a higher withdrawal amount.
Jon Luskin: Ricky, you're up next.
Ricky Speaker 2: Few questions. Morningstar research for your safe withdrawal rate - how were taxes taken into account?
Christine Benz: In terms of taxes, we did not factor in taxes into our safe withdrawal amounts. So, people who are pulling their retirement portfolio withdrawals from tax-deferred accounts that will be taxed as ordinary income, they'd obviously want to haircut their withdrawal amount accordingly.
Ricky speaker 2: If you're looking at more of a forward-looking type prediction, isn't that more prone to error compared to Bill Bengen where he is using historical history?
Christine Benz: Well, we think investors should do both. That you should keep an eye on history, perhaps use history as a starting point when thinking about withdrawal rates. But we think it's helpful to plug in starting yields as well as starting valuations with an eye toward figuring out what's safe going forward.
When you think about bond yields, they're extraordinarily predictive of what you're likely to earn from the asset class, at least over the next decade. There's a very neat relationship between starting yields and 10-year returns. So, we think that that is good input when thinking about retirement withdrawal calculations.
Jon Luskin: And to repeat what was mentioned earlier with respect to that Bengen distribution rate, that higher sustainable distribution of 4%, 4.7%. Again, that's based on historic US data, and it certainly can be argued that was an outlier in terms of market returns in the past. We might not see those sorts of returns again in the future, and that's what the conclusion Christine and her team's research comes to. Hey, we're probably going to look at something less than 4% going forward.
There is a fascinating research paper, I’ll link to in the show notes for our podcast listeners, “Is the United States a Lucky Survivor” that talks about how US market performance has been quite irregular compared to the rest of the world.
Ricky speaker 2: My last question is in regards to TIPS. Based on how they've acted, and they're actually a poor inflation hedge, do you find now that you're looking at TIPS differently?
Christine Benz: TIPS - Treasury Inflation Protected Securities - have not been a super great inflation hedge. We saw that very starkly in 2022, where investors who had especially intermediate-term TIPS or maybe a fund like Vanguard Inflation Protected Securities had fairly big losses.
And the reason, and I would direct you all to a great piece that my colleague John Rekenthaler had on morningstar.com today, the reason is that intermediate-term, long-term TIPS are incredibly interest rate sensitive. So, they tend to be more bond-like than they are inflation protective in terms of their behavior.
That's why I've tended to like shorter-term TIPS funds. So, Vanguard has a very good one, Vanguard Short-Term Inflation Protected Securities, in part because it delivers more or less pure inflation protection without all of the interest rate related volatility that comes along with intermediate-term and longer-term TIPS.
So, I think we saw a good illustration of why short-term TIPS make sense as a means of addressing or providing inflation protection from your portfolio. I-Bonds, I think also are a super good fit. But the main caveat there is that for larger investors especially it can be difficult for them to build a decent sized bulwark of I-Bonds with their portfolios.
Jon Luskin: Let's jump to Chris's question.
Chris speaker 3: Christine, I am an early retiree, all of my bonds are TIPS currently. I was wondering how that would relate to my success rate?
Christine Benz: We did not test a TIPS-only portfolio. But my guess is that using TIPS versus using the more diversified, blended bond portfolio that we used would probably not affect the safe withdrawal rate too much. My guess is that it would stay pretty close to what we came out with, which was that a 3.8% starting safe withdrawal rate was a good starting point for people just embarking on retirement today.
Jon Luskin: Christine, let's move on to the flexible strategies discussed in your paper. Tell us what sort of distribution rates folks
Christine Benz: I do think that so much of the great research that's been done in the withdrawal rate space by people like Wade Pfau or my former colleague at Morningstar, David Blanchett, has pointed to the value of being flexible.
So, in the baseline research that we worked on, we assumed that someone takes out X%. So, 3.8% on that balanced portfolio. $38,000 on a $1 million portfolio in that first year, and then inflation adjusts that dollar amount thereafter. So, basically kind of a plug and play, set it and forget it withdrawal rate system.
One thing we know is that most retirees are accustomed to tightening their belts at various points in time. They probably did it over their careers as their incomes ebbed and flowed a little bit, so they've tightened their belts in weak years, and they were able to spend a little bit more when things were better. We think that retirees are no different, that most retirees should be able to accommodate modest adjustments over time. And the benefit of being able to make modest adjustments to withdrawal rates is that you can start with a higher withdrawal amount.
So, we experimented with a variety of different withdrawal systems, flexible withdrawal systems within our research. We found that what's sometimes called the guardrails system - this is a system that was developed by financial planner Jonathan Guyton and computer scientist William Klinger - we found that guardrails approach lifted starting safe withdrawal rates the most, and in exchange there's a trade-off. You have to be willing to take less when the portfolio hasn't performed as well, and you can take a little bit more when it has performed relatively better. The safe withdrawal amounts with that guardrails approach, using a balanced portfolio system would deliver a 5.3% or 5.4% starting safe withdrawal amount.
So, you can see that's an appreciable difference. So, my advice for people embarking on retirement is to explore some of these flexible methods. That Guyton method that I just referenced, the guardrail method, does require a little bit more ongoing tweaking, but there are very simple adjustments like foregoing an inflation adjustment in the year after the portfolio has had a losing year. We found even that simple strategy takes starting safe withdrawal amounts up to 4.3%. So, actually over the 4% guideline that you so often hear about.
So, I do think that people should explore these flexible strategies. I think they can be incredibly beneficial. And plus, one thing that I have on my mind when I'm thinking about withdrawal rates is that we know that retiree spending over the lifecycle isn't a straight line, and many of us have seen this in action with older adults in our lives, whether parents or grandparents. We know that oftentimes the early years of retirement are the higher spending years. They're when people's health is good, when they have pent up demand because they've been working their whole lives.
They really have a lot of things that they want to do. I think that people who are just embarking on retirement should explore whether they could potentially spend more in those early go-go years of retirement in exchange for potentially taking less later on.
Jon Luskin: Going back to the fact that the simulated forward-looking sustainable distribution rates are going to be lower than what we've seen in the past. Looks like we're seeing the same thing for that guardrails approach. 5.3% in your research compared to 5.5%, I believe in the original Guyton-Klinger paper, which again suggests those US market returns in the past may not necessarily be what we're going to get going forward in the future.
Christine, perhaps you can tell us a little bit about which stock/bond mix provides the highest safe withdrawal rate?
Christine Benz: Sure, Jon. I will say this was somewhat counterintuitive to me when we embarked on this research last year where Jeff and John were running the data and came out with this low 3% range withdrawal rate assumption. And my thought was, well, let's dial up equities and see what happens. And interestingly, it doesn't really help, and it didn't help in the 2021 research, and it didn't help in this past year's research either. In fact, the best withdrawal rates are delivered by a more or less balanced portfolio.
And the key reason is that bonds have lower return assumptions attached to them, but bond returns are also much more stable and predictable. And so that's why the balanced portfolio tends to look better from the standpoint of starting safe withdrawal rates than does that portfolio with a higher equity allocation.
So, for example, using sort of that fixed real withdrawal system, the 100% equity portfolio can support just a 3.5% withdrawal rate, whereas, portfolios with asset allocations between 60% and 30% can support 3.8%.
Jon Luskin: In your most recent research paper, you show that there is that range, that 30% to 60% stock portfolio that's going to give you the highest sustainable withdrawal rate. That is what those simulations show.
And historically, Bengen, who looks at that past data, comes up with a similar result. 55% to 60% in stocks is what he shared is going to be that optimal portfolio for providing the highest distribution rate.
So, if that takeaway is going to be, hey, you don't want too much in stocks, you don't want too much in bonds, you want that balance that's going to help you achieve the highest when it comes to how much you can spend in retirement.
This one is from username WoodSpinner from the Bogleheads® Forums who writes: “For many of us, our withdrawal rates change significantly when we secure income such as a pension, social security, or annuities. I see this as a major issue in using any safe withdrawal rate guide. As I’m spending for my retirement, the relatively fixed distribution rates simply don't match my changing income needs. For example, we're now spending 5% to 6% of our portfolio, but we expect that to drop to 2% when social security
Does Christine have a proposal that allows for larger withdrawals early on with much smaller withdrawals later on?”
nd we had a related question from heyyou about the best withdrawal rate system.
Christine Benz: When I think about these fixed real withdrawal systems, whether it's Bill Bengen's 4% guideline or our 3.8% conclusion, in a way it's a little bit of a straw man because it assumes that someone is spending that fixed real amount in retirement.
In reality, we know that retirees don't spend that way. So, we know that people tend to spend less in the mid- to late-years of retirement. We also know that demands on the portfolio change based on income sources coming online, or perhaps there might be one-off cases where someone sells a second home or something like that. So, the portfolio size becomes larger with the addition of that asset.
And that's one reason why I like the idea of retirees revisiting their portfolio withdrawals on a year-by-year basis rather than setting a single starting withdrawal rate and never looking back. You can and should revisit it based on how your portfolio has performed, based on how your income sources have changed, and potentially you have more income coming in the door due to social security or whatever else it might be.
And also based on the addition or subtraction of other assets that you might be bringing into the plan or taking out of the plan. So, really important to revisit this stuff on an ongoing basis, and if possible, be a little bit flexible with respect to your withdrawal amounts.
Jon Luskin: I'm going to echo your point on flexibility. That's going to be the key to any plan, being able to change it as necessary.
This question is from the Bogleheads® Forums from username iim7V7IM7 who writes: “One year's changes turned from 3.3% to 3.8%. How is this model so sensitive to market changes?”
Christine Benz: We rely on our team of researchers in Morningstar investment management for these return forecasts. And the key reason on the equity side is something we all lived through. We know that the broad stock market was down about 20% in 2022. This is the US market. And so, that tends to lift return prospects.
So just as an example, looking across equity categories - and we do use a diversified basket of different equities - in 2021 the return assumptions ranged from a high of 11% for US small value stocks to a low of 6%. That was at the 2021 return assumptions. At 2022’s research, the high was in the neighborhood of 12%. Again, for US small value. Low of 10% for US large growth.
So, that's an appreciable increase. Again, dovetailing with the losses that we saw and the subsequent related decline in equity valuations.
On the bond side, the bumps up were just as meaningful, largely because of higher yields which caused the dislocation in stock and bond prices that we all lived through last year. In 2021’s research, our expectations for future bond returns – 30-year bond returns - were in the neighborhood of 3% or sub-3% in line with yields or perhaps a bit above where yields were last year. This year, as we revisited the bond yields and bond returns, the return expectations for fixed income - both US investment grade bonds and foreign bonds - were in the neighborhood of 4.5%-5%. So yes, pretty big increases, largely due to higher yields and lower equity valuations.
Jon Luskin: All right. I'm going to add RSW, go ahead.
Rodney speaker 4: Were the portfolios that you were looking at just US equities and US bonds, or was it more global in nature?
Christine Benz: We did look at global portfolios. We give a slightly higher return assumption to non-US stocks than we do to US stocks. So, I would say that if for whatever reason someone's using an all-US portfolio, they would probably want to nudge their withdrawal rate downward a little bit because we have slightly lower return expectations for US stocks versus non-US.
Jon Luskin: Christine, and you can correct me if I'm wrong here, in the model allocation that you use, you've got a slight overweight to small cap compared to large. That is, it's not a market cap portfolio, it's not something like VTSAX. You're overweighting small cap and then you're also overweighting US compared to international as well.
And I think that reflects a lot of the portfolios of the folks that are investing. They're going to overweight US; they're going to have that home bias. And a lot of folks like to overweight small cap, too, in the hopes that they're going to earn a little bit more with that approach.
Christine Benz: Yeah, Jon, in our base case we have 60% of the equity weighting going into US large caps, 20% which you're right, it is an overweight relative to a Vanguard total stock market, which is I think sub-10%. So, we've got 20% in small cap and then 20% in foreign stocks. Whereas if you're looking at sort of a total world market capitalization approach, you would have more like a 40% non-US weighting, 60% US weighting. So, there are some biases built into the diversified equity mix. On the fixed income side, we used 80% US investment grade bonds, 20% foreign.
So, you're right that many investors, as a matter of course, do not have a full market cap weight in non-US stocks. They might have a little bit more in small cap stocks. That was the sample basket that we used for our returns and in turn withdrawal rate assumptions.
Jon Luskin: This one is from username USAFperio from the Bogleheads® Forums who writes: “Your predicted expected safe withdrawal rate grew from 3.3% to 3.8%. Were you surprised that the short-term, one-year change in market valuation and bond yields could lead to such a significant change in the amounts that a 30-year time horizon would produce?”
Christine Benz: I was surprised I suppose, but we did see a big turn in yields. Certainly, that was really what drove all of the market activity on the stock and bond sides in 2022. So, we had big bump up in yields, which contributes to higher return prospects for fixed income. It's really that simple. And, we may have, if we're moving into some sort of recessionary environment, yields may head back down. In fact, we've even seen a little bit of that over the past couple of months.
But yields are really driving the car in a lot of ways and higher yields do embellish the prospects for bond returns and lower valuations point to higher stock returns. So, I can't say I'm super surprised because it was a pretty big market dislocation event over the past year.
Jon Luskin: Looks like Ricky has returned to ask another question.
Ricky speaker 2: Christine, we mentioned Wade Pfau earlier. Wanted your thoughts on the new RISA that he developed.
Christine Benz: What you shorthanded as RISA - Retirement Income Style Awareness - is a system developed by retirement researcher Wade Pfau. Wade is one of the leading lights in retirement research. Many of the listeners, I'm guessing, will know of Wade's work.
And the key idea, which I love, is kind of like retirement style meets investor. So, the idea is that we're all just geared a little bit differently with respect to our interest in security. For example, some people might want to say, well, I would much rather spend less than I could if it means that I have almost an ironclad guarantee that I'd never run out.
So, some people might just be very, very risk averse. They might be very focused on basically replacing their paycheck that they had while they were working to kind of keep that going in retirement. At the other end of the spectrum might be someone who is much more willing to perhaps take higher withdrawals early on in retirement if it means that they may have to course correct later on. Such a retiree may be more comfortable with a higher equity weighting if it means that spending could increase and also residual balances at the time of death might be larger, that you might leave more behind. So, people bring all these different preferences into what they want their retirement paycheck to look like.
I do think that Wade's retirement income style awareness is just a crucial step forward in the retirement research space. I have his book here on my desk. I think it's certainly must-reading for anyone who's doing any sort of retirement advice, but also just for casual students of retirement. It covers every important thing that you need to be thinking about if you're putting together a retirement plan. It's not light reading, but I really think it's essential reading if you're super interested in this topic.
Jon Luskin: Christine, any final thoughts you'd like to share about what folks can spend in retirement before I let you go?
Christine Benz: Well, thanks Jon. A couple of them I mentioned earlier, but I'll reiterate just get some help that I know and love that the Bogleheads® include a lot of dedicated DIYers and these folks have been really successful and have done a great job of minimizing all of their investment related costs, including in some cases investment advice costs.
But I do think that retirement is so much more complicated and such a critical juncture that it's a place where it can really make sense to pay for an advisor. And that doesn't necessarily mean that you have to sign on for an ongoing fee in perpetuity. It can mean that perhaps you contract with an advisor on an as-needed basis, maybe an hourly basis every couple of years in your retirement.
I think that getting that advice can be money well spent on withdrawal rates and tax planning in any number of areas in the realm of retirement planning. So that's the first thing.
The second thing is to try to be as flexible as you can possibly be. So being willing to adjust your portfolio withdrawals on an annual basis based on how your portfolio has performed, based on how your income needs may have changed, your spending needs may have changed. All of those things I think necessitate a re-look at your withdrawals throughout your retirement.
And finally, just paying attention to all manner of costs. So, there are certainly investment product costs, and I think the Bogleheads® have done such a great job of shining a light on keeping costs down in terms of index products and focusing on cheap ETFs and index funds for the bulk of your portfolio. Investment advice costs, really ‘cheaping out’, not overpaying for services that perhaps you're not getting.
And tax costs, I would say fall into that bucket as well. And the nice thing about managing tax costs is that they at least fall somewhat under that heading of costs that we exert some level of control over that with a certain amount of tax planning, you can help minimize the tax costs you pay on your portfolio.
Jon Luskin: That's all the time we have for today. Thank you to Christine Benz for joining us today, and thank you for everyone who joined us for today's Bogleheads® Live.
The next Bogleheads® Live, we're going to have Diane Gaswirth joining us to answer your questions about Medicare. That'll be Thursday, February 2nd, 11:00 AM Pacific, 2:00 PM Eastern.
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