Sustainable Withdrawal Rates by Return Environment: A Time-Varying Bayesian Analysis

As investors depend more on their investment portfolios to generate income in retirement, financial advisors have developed rules of thumb to estimate a portfolio’s sustainable withdrawal rate (SWR). The most famous heuristic is Bengen’s “4% rule.” The strength of these rules is their ease of implementation. Among their limitations is their insensitivity to long-term variation in return environments. We borrow a statistical technique from the macroeconomics literature—a Bayesian vector autoregression with time-varying parameters—to model the impact of changing return dynamics on SWRs. We first illustrate how changes in stock-bond correlation, return and inflation volatilities, and returns have affected historical SWRs. Building on the consensus forecast, we then use these insights to identify 2.8% to 3.3% to be a relevant SWR for those retiring in today’s evironment characterized by low prospective returns and inflationary uncertainties.