Christine Benz: Hi, I'm Christine Benz for Morningstar. I'm here at the Morningstar Investment Conference, and I'm joined today by John Ameriks. He is a principal at the Vanguard Group. He's also head of the firm's investment counseling and research group. John, thank you so much for being here.
John Ameriks: I'm happy to be here, Christine.
Benz: John, I know one area that your group has done a lot of work on is the area of withdrawal rates, so setting your in-retirement withdrawal rate. Our readers are mainly individual investors attempting to navigate this complex decision on their own. I'm wondering if you can share some insight into where to begin this process and also what sort of variables you need to be armed with in order to make a good decision.
Ameriks: I'd be happy to. I hope we have a lot of time.
Benz: It's a big topic and evolving. There is a lot of research being done including some that you all have come up with.
Ameriks: There are studies that go back a long time looking at withdrawal rates, and it's likely that a lot of people have heard about the basic result from a lot of that, which has been to focus on the so-called 4% withdrawal rate.
Benz: So let's unpack that for a second because I think sometimes people think while that's 4% fixed year-in, year-out, but really that wasn't the underpinning of that research.
Ameriks: Right. Exactly. That seems simple, the 4% withdrawal rate. But what's in the denominator? And how does the numerator work, and what's exactly is the strategy? So these studies, what they will do is they will look at a diversified portfolio, usually with the fixed asset allocation that tends to be what we would call a moderate allocation, say, anywhere between 40% in equities to 60% in equities. It's a withdrawal rate from a portfolio that looks like that.
When we say 4%, what do we mean? Well, we mean spend an amount that's equal to 4% of that balance as of the start date. So a 65-year-old enters retirement with $100,000 in an IRA, and we say, well, let's think about 4%. Well, 4% on $100,000 is $4,000 a year. The strategy is then to increase that $4,000 withdrawal every year going forward by the rate of inflation. That's how most of these studies are done. So, 4% applies at the beginning, but as you go on, depending on what the markets do, it might be a larger or smaller portion of your portfolio. That's the modeling framework that it's done, and the question that leads to the 4% answer is, "I've got a portfolio. How much can I spend? Is it 4% or 5% or 3% of my total balance? How much can I spend and not have it run out of money in, say, 25 or 30 years?"
Benz: So, if the market goes down, and I'm using that initial withdrawal amount and I've been adjusting it for inflation, if the market goes down a lot and my balance drops a lot, I could be way higher than that initial 4%, maybe dangerously higher.
Ameriks: That's exactly right. You can imagine, as time goes on and you're in year 28 of such a drawdown strategy, you might be spending an enormous fraction of what's left or in a really good market scenario, you may not be spending very much. So that's the analysis that went into determining that 4% rule. I think at this point it's probably important to step back a little bit and think more broadly about, well, what's that useful for and how should I think about those drawdown rules over time?
I think these types of analyses are really good for people who are considering what they should start with and what's reasonable, but I don't know how much these rules really help people with every year. Should I really do that every year? I should adjust my portfolio by inflation even that means I'm spending half of my assets in one year? I don't think many clients are comfortable with that. Certainly, many financial advisors wouldn't be comfortable with that. You got to understand that the reality that you experience over time may not line up with what those assumptions were in that kind of analysis.

Benz: So some of the work that you and your team have done has centered around this idea of sort of setting upper and lower limits on how much you can take, and the goal there is to prevent you from taking too much in certain years. Can you talk about how that might work to sort of set those ceiling and floors as you call them?
Ameriks: Sure. So, the idea there is saying, well, we know that one of the most important things about a retirement savings plan is flexibility. But we also know that what a lot of people want out of a retirement spending plan is stability, right?
Benz: A more or less fixed paycheck. Yes.
Ameriks: That's right. They would love to able to take risky assets and spend a fixed dollar amount every year and not have to worry about running out of money. Unfortunately, doing what I said and doing those two things doesn't go together. If you're taking risk with the assets, you can't spend a fix amount with zero likelihood of running out of money.
So, you got to trade off stability and the payout with flexibility around being able to lower the payout at least to some degree when the portfolio falls in value. If you actually take a step back and look at more of the academic studies on saving and spending--these studies predate a lot of financial-planning work that was done on this--you're going to see rules that look more like proportional rules in terms of spending through time, a particular fraction of assets that someone might have. In fact, not only are you going to see a rule that spends a particular fraction of what someone has in terms of assets, but the size of spending--the fraction itself--is going to change depending on life expectancy. It also depends on horizon. You can see a little bit into that in the rule that's used for required minimum distributions which basically spends a different portion of assets every year as people get older.
Benz: So, general rules of thumb, and I know it's hard to encapsulate them, but it sounds like you're saying maybe use that 4% rule as a starting point, plan to be flexible, also plan to maybe ratchet your spending rate up slightly as you are, say, into your mid-80s. If leaving money for your kids and grand kids wasn't a concern, you could potentially spend more at that juncture?
Ameriks: Sure. When we do these analyses for clients, we'll look at two things. We'll look at how the portfolio is invested, and what the horizon is. Both of those things are going to slightly affect what level of withdrawal we'd recommend for at least the short term as somebody gets a plan set up. So, 4% is fine for somebody who has got 30 years to go and is in a moderate portfolio. But as somebody gets further on in retirement, as you are saying, then they may have half that time horizon to spend, and that means they can spend a little more without running the risk of running out over that time, or running the same level of risk that they were running by spending a lower rate with a longer horizon. So, circumstances are going to matter a lot.
I think that rules are very helpful in giving people a place to start, and then you really do over time have to look at both what remaining time frame do I have, and what are my resources going to look like when you're thinking about spending from then on.
Benz: John, I think we could talk all day about this topic, but thank you for sharing your insights here in the short video. We appreciate you being here.
Ameriks: Happy to do so, Christine. Thanks.
Benz: Thanks for watching. I am Christine Benz for Morningstar.