Comparing 5 retirement portfolio withdrawal strategies

Let’s start with the obvious: How a person withdraws money from their retirement portfolio matters. If thoughtfully executed, portfolio withdrawals need not capsize a retirement portfolio. 

But that naturally begs the question, what represents a thoughtful withdrawal system?  

I propose that for many if not all retirees, the primary objective is for the portfolio to meaningfully contribute toward sufficient retirement income, without depleting the portfolio prematurely.  

Toward that objective, I analyzed five different withdrawal methods and the associated impact on: the portfolio’s ending balance after 25 years of withdrawals, the average annual withdrawal, the total amount withdrawn, the percentage of time the portfolio grew in value and the portfolio failure rate. 

The five retirement portfolio withdrawal methods that I focused on were: 

• A fixed amount of $50,000 withdrawn every year for 25 years, with no cost of living adjustment (COLA).
• A fixed amount of $50,000 withdrawn in year 1, followed by a 3% COLA in years 2 through 25.
• A fixed percentage withdrawal of 4% of the year-end portfolio balance.
• A fixed percentage withdrawal of 5% of the year-end portfolio balance.
• Annual withdrawals determined by required minimum distribution (RMD), with the annual RMD withdrawal percentages starting at age 73.

These five withdrawal methods likely capture the vast majority of ways in which money can be withdrawn from a retirement portfolio.
READ MORE: Financial advisors are divided over this RMD tax strategy

In this analysis, each retiree had a 60% equity/40% fixed income portfolio (comprised of 40% large stock, 20% small stock, 30% aggregate bonds and 10% cash). The total annual portfolio cost was assumed to be 125 basis points, and the starting balance was set at $1 million. The length of each withdrawal period was 25 years. The annual returns from 1926 to 2024 of four core indexes determined the performance of the portfolio over the 99-year period: S&P 500, Russell 2000, Bloomberg Aggregate Bond Index and 90-day Treasury Bills. 

During this 99-year period there were 75 rolling 25-year periods. The first was from 1926 to 1950, the second from 1927 to1951 and so on. By use of this approach, the experience of 75 different retirees was studied — each person experiencing their own specific sequence-of-returns in their four-asset 60/40 retirement portfolio. 

When analyzing withdrawals from a retirement portfolio (or any portfolio), it’s imperative to study enough rolling periods to account for the impact of various sequences of returns experienced by the portfolio. This analysis is not Monte Carlo; rather, it is analysis of actual historical returns of four well-known indexes.

The analysis made four important assumptions: 

• Each retiree rebalanced their 60/40 portfolio at the end of each year. 
• There was no “bailing out”; that is, the retiree stayed in the 60/40 portfolio each and every year. 
• The impact of taxes and inflation was not considered, so the analysis results are in “gross” terms. 
• Withdrawals occurred once each year at the end of the year. 

Now, to the results…

The above analysis of the five different withdrawal strategies indicates several startling results.

First, regardless of how money is withdrawn from the portfolio, it tends to grow over each 25-year period. Second, it’s really hard to kill a portfolio within 25 years. That is, it’s very difficult to liquidate a retirement portfolio that has at least a 60% equity allocation. 

READ MORE: Forget retirement buckets. Advisors prefer these withdrawal strategies

Third, retirement portfolios can fail when the withdrawals are cash-based (the first two scenarios above), rather than percentage-based. Why? When specifying a set amount of money that will be withdrawn (with or without a cost of living adjustment), the retiree is essentially ignoring what happened to the portfolio that year. For example, a cash-based withdrawal at the end of 2008 stayed the same (or was increased by the stipulated COLA), even though the portfolio likely got hammered. That’s the problem. A cash-based approach is “blind” to the portfolio’s return each year. By contrast, a percentage-based approach (such as the well known 4% rule) self-adjusts the withdrawal downward after tough market years like 2008 or 2022.  

Said more simply, a percentage-based withdrawal has both eyes and heart. This simple dichotomy — cash-based vs. percentage-based — is the single most important variable in determining whether or not a retirement portfolio lives or dies.

The key “variable” in all of this is really in the hands of the retiree: sticking with their retirement portfolio asset allocation through thick and thin. 

Hopefully this analysis will give advisors’ skittish clients more confidence that an annually rebalanced 60/40 portfolio, paired with a percentage-based withdrawal method, nearly guarantees that their portfolio will not only survive but will very likely grow during the first 25 years of their withdrawal period.