The Ultimate Guide to Safe Withdrawal Rates – Part 19: Equity Glidepaths in Retirement

One of the most requested topics for our Safe Withdrawal Rate Series (see here to start at Part 1 of our series) has been how to optimally model a dynamic stock/bond allocation in retirement. Of course, as a mostly passive investor, I prefer to not get too much into actively and tactically timing the equity share. But strategically and deterministically shifting between stocks and bonds along a “glidepath” in retirement might be something to consider!

This topic also ties very nicely into the discussion I had with Jonathan and Brad in the ChooseFI podcast episode on Sequence of Return Risk. In the podcast, I hinted at some of my ongoing research on designing glidepaths that could potentially alleviate, albeit not eliminate, Sequence Risk. I also hinted at the benefits of glidepaths in Part 13 (a simple glidepath captures all the benefits of the much more cumbersome “Prime Harvesting” method) and Part 16 (a glidepath seems like a good and robust way of dealing with a Jack Bogle 4% equity return scenario for the next 10 years).

The idea behind a glidepath is that if we start with a relatively low equity weight and then move up the equity allocation over time we effectively take our withdrawals mostly out of the bond portion of the portfolio during the first few years. If the equity market were to go down during this time, we’d avoid selling our equities at rock bottom prices. That should help with Sequence of Return Risk!

GlidepathPlot
Static Asset Allocation vs. Glidepath in (early) retirement. 80% static equities vs. a glidepath going from 60% to 100%.

So, will a glidepath eliminate or at least alleviate Sequence Risk? How much exactly can we benefit from this glidepath approach? For that, we’d have to run some simulations…

Background on glidepaths

Target date funds use a time-varying asset allocation depending on the participant’s age. The idea is that young investors can and should take on more risk and hold a higher portfolio share in equities. Then, as retirement approaches, investors shift more into bonds to reduce risk. In fact, you don’t even have to do this shift yourself; Vanguard or whoever your provider may be will do it for you! Here’s Vanguard’s take on the glidepath, see chart below. The equity share (domestic plus international) in their target date funds starts at around 90%, drops to around 50% at the traditional retirement age of 65 and then further drops to 30% by age 72.

VangardScreenshotGlidepath
Vanguard’s proposed Glidepath: The equity weight declines after age 40. After age 65, the rate of equity weight reductions accelerates until the early 70s and then stays constant. Source: Vanguard.

But recent research has shown that Vanguard (and many other providers of target date funds) actually got it wrong, at least for the post-retirement glidepath. The glidepath of equity weights should ideally start to increase (!) again once you retire. Michael Kitces wrote about this topic (on his blog here and here and in an SSRN working paper joint with Wade Pfau) and proposed to keep the minimum equity share at or around the retirement date before starting to raise the equity weight again during retirement.

KitcesScreenshotGlidepath
Michael Kitces’ proposed Glidepath: The equity weight increases during the early years of retirement. Source: kitces.com.

The rationale is that the rising equity glidepath in retirement would be insurance against sequence of return risk. After all, the number one reason retirees run out of money is bad returns during the first few years of retirement. A low equity allocation shields you from short-term equity volatility, but longer-term you will need the high equity share to make it through 40, 50 or even 60 years of retirement. So, a dynamic stock/bond share would thread the needle to achieve both long-term sustainability and short-term protection.

Of course, as with all of the traditional retirement research, it has limited use for the early retirement community. My experience has been that a lot of the research targeted at the traditional retirement crowd, calibrated to capital depletion over a 30-year horizon, is less applicable to the FIRE crowd. For example, Safe Withdrawal Rates have to be lower over a 60-year horizon than over a 30-year horizon. And, equally important, equity weights have to be higher over a 60-year horizon to ensure long-term sustainability. Case in point, the 30% equity weight at the retirement and 60% in the long-term as indicated in the Kitces chart above would be way too low for early retirees!

So, when unhappy with the whole Kit(ces) and Caboodle of hand-me-down research, what am I supposed to do? If you want something done and done right, you just have to do it yourself! That’s where the Big ERN simulation engine comes in handy!

Simulation assumptions:

  • Monthly data from January 1871 to July 2017.
  • A 60-year retirement horizon.
  • Retirement dates from January 1871 to December 2015 (with extrapolations using conservative return forecasts for bonds and stocks beyond July 2017).
  • Final value targets of 0% (Capital Depletion), 50% of the initial real value and 100% of the initial portfolio (in real terms).

For each of the 1,700+ cohorts, we calculate the safe withdrawal rate, i.e., the initial withdrawal percentage that exactly achieves the final target value after 60 years, assuming withdrawal amounts are adjusted for CPI-inflation regardless of the portfolio performance. As usual, we calculate the SWRs for the 21 different static Stock/Bond allocations (0% to 100% stocks in 5% increments). But we also simulate a total of 24 different glidepaths, comprised of the different combinations of glidepath parameters:

  • Two different end points: 80% and 100%. Why not lower end points? As we will see later, the long 60-year retirement horizon necessitates a much higher (long-term) equity weight than the often-quoted 60% or even 50%.
  • Three different starting points: 20, 40 and 60 percentage points below the end point.
  • Two different slopes. Notice that I had to increase the slopes for the glidepaths that cover more ground, otherwise, the transition would take way too long:
    • 0.2% and 0.3% per month for the glide paths starting 20 percentage points below the max,
    • 0.3% and 0.4% for the paths starting 40 percentage points below the final target,
    • 0.4% and 0.5% per month for the paths that start 60 percentage points below the final target.
  • Two different assumptions for the glidepaths: Passive vs. Active
    • Passive means that we stubbornly increase the equity weight every month by the slope parameter.
    • Active means that we increase the equity share only when equities are “underwater,” i.e. when the S&P500 index is below its all-time high. We want to avoid shifting out of bonds too early, i.e., before the market peak and then having insufficient bond holdings when equities take a dive.
SWR-Part19-Chart03
12 Passive glidepaths with different starting, and final equity weights and different slopes. The transition takes anywhere between 5.5 and 13 years!

The “active” glidepaths, of course, are dependent on the retirement cohort. The transition from, say 60% to  100% equities would take a little bit longer depending on how equities perform during that time, see a sample of active glidepaths for the January 1965 to January 1980 cohorts below:

SWR-Part19-Chart04
Sample glidepaths for retirement cohorts 1965-1980 (January each year) for the 60->100%, 0.4% monthly steps. The equity weight shifts up if the S&P500 index is below its all-time-high. If the S&P500 is at the all-time high, the weight stays as is.

Results:

Let’s start with the failure rates of our preferred safe withdrawal rate, 3.50%. In the chart below, I plot the failure rates of three static equity weights, 60%, 80%, 100%, as well as the various glidepaths. Those with a final equity weight of 80% at the top and with a final equity weight of 100% at the bottom. First, let’s do this for all 1,700+ monthly retirement cohorts regardless of equity valuations (“All CAPE”):

SWR-Part19-Chart01
Failure Rates of the 3.5% Rule: 60/80/100% static equity weights vs. glidepaths with 80% final value (top panel) and 100% final value (bottom panel). 1871-2015.

Some patterns emerge from this chart:

  • There will be at least a few glidepaths with lower failure rates than the static allocations. It seems that the 80% to 100% and 60% to 100% glidepaths deliver consistently lowest failure rates, regardless of the final value target!
  • Who would have thought that the maximum long-term equity weight delivers the lowest risk? This goes back to the superior equity long-term expected returns; once you make it through the shaky first 5-10 years exposed to sequence risk you want to max out the equity weight!
  • The very long transitions over 60 percentage points (20 to 80% and 40 to 100%) tend to be pretty consistently inferior to the other glidepaths. The 20 to 80% glidepaths are even inferior to the static 80% and 100% allocations! Apparently, the initial stock weight was too low and/or the transition took way too long (even with the accelerated slopes of 0.4% and 0.5%!)

Do glidepaths become more useful when the Shiller CAPE is high?

As we have pointed out numerous times before (for example, in Part 3 of the series), the Shiller CAPE is strongly correlated with safe withdrawal rates. Plain and simple: Sequence of Return Risk is elevated when the CAPE ratio is high! Is that also reflected in the glidepath performance? You bet, see chart below:

SWR-Part19-Chart02
Failure Rates of the 3.5% Rule: 60/80/100% static equity weights vs. glidepaths with 80% final value (top panel) and 100% final value (bottom panel). 1871-2015. Conditional on the Shiller CAPE>20.
  • First, notice that the failure probabilities of the static rules are now much higher due to the higher CAPE ratio. Even a capital depletion target fails with about 17%, 7% and 12% probabilities for the static equity weights of 60%, 80%, and 100%, respectively.
  • Most glidepaths pretty consistently beat the static equity weights. The consistently best performers are the 60 to 100% glidepaths and the active glidepaths perform slightly better than the passive ones. The failure rates are less than half those in the static allocation simulations!
  • The 20 to 80% and 40 to 100% glidepaths are still inferior to the other glidepaths. And the 20 to 80% glidepaths are inferior to the even the static asset allocations.

More on the distribution of SWRs: Failsafe and other SWR percentiles

A lot of very risk-averse retirees like to set their SWR to the failsafe SWR in historical simulations. That seems very conservative, but I can see where they are coming from. If your strategy would have handled the Great Depression, the nasty 1970s/early 1980s, and the volatile 2000s you can probably also use it in 2017 without too much worry!

In the table below, I calculate the failsafe SWR, i.e., the minimum historical safe withdrawal rate (60-year horizon, 0% final value), as well as some other percentages (1st percentile, 5th, 10th and 25th). So, for example for the 80% fixed equity allocation, the absolute lowest historical SWR would have been 3.14%. A 3.43% initial SWR would have failed 1% of the time, 3.59% would have failed 5% of the time, 3.86% would have failed 10% of the time and 4.48% would have failed 25% of the time. I don’t think planning for a 25% or even 10% failure probability is very prudent – personally, I try to target a failure probability in the single digits, e.g., 5% – but I display the numbers just in case someone wonders.

The left portion of the table is for all possible retirement start dates (about 1,700 of them, monthly data from 1871 to 2015). The right part of the table is for those months when the Shiller CAPE ratio is above 20. In the top portion of the table, I also marked with green boxes the maximum value among the static asset allocation rules in each column. Notice how the maximum in each column is at between 75 and 100%! To make it through a 60-year retirement, you can’t have a 60% or even 50% equity share. That only works for 30-year horizons! Also notice that with a CAPE>20 all numbers in the far right column are <4%, so the 4% had a failure rate of over 25% regardless of the equity glidepath!

SWR-Part19-Table01
Failsafe and other percentiles of the SWR distribution for different Static asset allocations (top panel) and the 24 different glidepaths. The left panel is for all retirement dates, the right panel for CAPE>20 at the start of the retirement. 60-year horizon, final Value target 0% (capital depletion), monthly data 1/1871-12/2015.

In any case, 60 to 100% glidepaths generate the consistently best SWRs. For the über-conservative FIRE planners who are looking for the failsafe 60-year SWR conditional on our current 20+ CAPE environment, a fixed 75% stock allocation would allow a withdrawal rate of only 3.25% and that’s already the max over the static allocation paths! The 60 to 100% glidepaths would have allowed between 3.42 and 3.47%. That’s an improvement of between 0.17% and 0.22%. It doesn’t sound like much but it’s an improvement of between 5 and 7% of annual withdrawals. Not bad for doing a simple glidepath allocation.

Likewise, if I’m OK with a 5% failure probability conditional on a CAPE>20, then the static stock allocation of 80% would give me an SWR of 3.47%. The glidepaths would have allowed between 3.57% and 3.63%. Only an additional 0.16%, but that’s about 5% more consumption every year!

So, we won’t get all the way to 4%, but we bridge about one-third of the way, simply by playing with the asset allocation over time.

A small caveat, though; the calculations raise the question: do we get something for free? Is this some sort of a money-making arbitrage machine? Of course not! A glidepath will deliver a higher safe withdrawal rate if you have an equity drawdown early on in retirement. But the opposite is true as well. That 60 to 100% glidepath that performed so well during the major Sequence of Return Risk disasters will also underperform if stocks rally during the first few years of retirement. Let’s look at the table below that displays the SWRs of the 60%, 80% and 100% static equity weight and the 60 to 100% glidepath with a 0.4% monthly slope conditional on equity performance. As we already know, it beats the static equity allocation rules significantly when retiring at the market peaks (=worst time to retire). But the glidepath also falls significantly behind the 100% equity allocation if you were to retire at one of the three market bottoms (=best time to retire). It handily beats the constant 60% allocation and is slightly inferior to the 80% constant equity allocation. But I wouldn’t really care too much about falling behind in that case. You still get phenomenal SWR, just a little bit worse than the even more phenomenal SWRs of the 100% equity allocation.

SWR-Part19-Table02
SWR comparisons. A glidepath helps you when you retire close to an equity market peak but hurts you when you retire at the equity market through!

Conclusion

Early retirees need the power of equity expected returns to make the nest egg last for many decades. Even more so than the traditional retiree at age 65! But that exposes us to Sequence of Return Risk. An equity glidepath can alleviate some of the negative effects of Sequence of Return Risk. But it shouldn’t come as a surprise that you will never completely eliminate the risk. For a given withdrawal rate, say 3.5%, we can only reduce the failure rate while leaving some residual risk. And likewise, the 4% rule would still not be safe for today’s early retirees even with an equity glidepath.

Moreover, an equity glidepath is like an insurance policy. A hedge against a tail event! On average it will cost you money, but if and when you need it the most it will likely pay off. Exactly when the static stock/bond allocation paths had their worst sustainable safe withdrawal rates you get slightly better results but you also give up some of the upside if the equity market “decides” to rally some more right after your retirement. But that’s a good problem to have!

We hope you enjoyed today’s post. Please leave your comments and suggestions below and make sure you check out the other parts of this series:

 

124 thoughts on “The Ultimate Guide to Safe Withdrawal Rates – Part 19: Equity Glidepaths in Retirement

  1. While I appreciate your analysis and statistical approach (I am a an engineer), I do think single digit failure rates are very conservative estimates for retirement planning. Not many things in life are that certain. My whole professional career has been in the oil and gas business so measurement of risk and reward are ingrained in my logic. It may seem unreasonable from a risk standpoint to suggest that someone should have 30x their current spending with a 80% equity portfolio to retire. There are many adjustments that can be made and if planning well they can avert ultimate portfolio collapse. One of the things that higher net worth may allow is reloading the portfolio with second homes, land etc. which is really not explicitly contemplated in your commentary (probably beyond the scope of the article).

    Additionally, most research has shown that in the case of typical retirement (30 to 40 years) the later years are when we approach the spending pattern of our early retirement years (the “smile”). When one looks at the assets on hand, liquidity of other assets etc. the analysis while academically rigorous seems overly conservative.

    Thanks for the work and I do appreciate your graphical communicative skills, it reminds me of our probablistic models in my former career.

    Liked by 1 person

  2. I’m loving this series. Maybe you talk about this elsewhere, but is there a good strategy for getting to a 60/40 allocation at the start of your retirement? I’m not going to just wake up with that allocation, and right now my strategy is 100% equities to get there as fast as possible (or fail trying). I imagine the tax consequences of re-allocating the day before you retire are pretty bad as well.

    Liked by 1 person

    • Ha, that’s a tough one. Not just 60/40 but also mortgage-free.
      One route would be to move to a cheaper location, pocket the extra cash from the home sale and put that in bonds.
      Another route: cold-turkey move a substantial portion of your 401k from stocks to bonds where you have no taxable capital gains from the portfolio shift!

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      • Thanks for the reply!

        Just trying to follow the 401k strategy: if I put the 40% bond allocation in my 401k, then during the glidepath portion of retirement, I would: shift .3%-.4% of that over monthly to equities in my 401k, and sell an equivalent amount of equities from my taxable accounts to cover my living expenses?

        One consequence of this I don’t quite understand would be the taxes at the end when I withdraw from my 401k. If the account is substantially bonds for a 5-10 years, assuming the stock market hasn’t fallen, then the balance wouldn’t be as big in the end (which is 30 years for me)…

        Do you explain the benefits of a cash buffer over a bond glidepath in any of your articles?

        Liked by 1 person

        • How much you shift depends on the particular monthly equity and bond returns. So, withdraw from the taxable account (all equities, I presume) and shift the S/B allocation to target the new shifting equity weight.
          After you’re done with this you should be at 100% equities in your 401k. Some of which you picked up during the downturn. All withdrawals from there are taxed as ordinary income.
          I haven’t compared the cash buffer with the glidepath yet. Good suggestion! They have similar features!

          Liked by 1 person

  3. First, let me say I’m a huge fan and find your research absolutely stellar. However, I find a few of the claims you are making to be potentially misleading. This one in particular to me is worth highlighting: “…retiring at the market peaks (=worst time to retire)”.

    While the market peaks around 1999 and 2008 certainly fit this to a tee, these are really exceptions not rules. There are literally hundreds and hundreds of other times when retiring near all time highs would have been the BEST time to retire (take 1982 as a classic example, the S&P hit an all time high and continued to make new all time highs for another 17 years!). That all time high was one of the absolute best times to retire, not the worst. We made all time for over a decade, each one of them was a perfectly great time to retire and to build wealth beyond most people’s wildest dreams.

    Liked by 1 person

      • You’re misunderstanding what I’m saying , sorry I don’t think I worded it quite right. What I meant to say was from 1982 all the way through to 1999 the market went on to hit all time high after all time high. Hundreds and hundereds of them. Even a day like Black Monday looks like a blip on the radar in the grand scheme of things.

        At nearly any one of those hundreds and hundreds of ATH’s the claim could have been made that “retiring at market peaks is the absolute worst time to retire.” Well no, actually almost all of these ATH’s represented some of the best times to retire in the history of our country, and you’d probably know better than me the appox.time when that stopped being true (obviously some amount of time before 1999).

        Point being that All time High’s in the market can be phenomenal times to retire, but it really depends on how extended from the base the market is (by the time we hit 1999 we were WAAAYYY extended, and the market went on to consolidate its gains for the next ~15-20 years depending on how you want to measure it, of course with a second even bigger bear market in between).

        The main point is that its way more complicated than to simply make a blanket statement that “retiring at market peaks are the worst time to retire.” They can actually be great times to retire.

        Liked by 1 person

        • We are both right. When I say “market peak” I mean the peak right before the next bear market. A time series peak that we assigned after the fact (after we confirmed a new bear market occurred subsequently).
          You seem to broaden the definition to each TEMPORARY peak before then. I agree that a fresh ATH as in the early 1980s or even 2012/13 is a good time to retire despite the fresh ATH. But you do realize that we’ve now reached a CAPE of 30+?! Very different from the beaten down market in the early 1980 with the CAPE in the single digits.

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          • I agree, but you only know the peak in hindsight. What you know today only happens on the left side of the chart. So when people say, “we are at an all time high in the market” it always refers to the left side of the chart. And when we hit these all time highs its always “we’re at a peak”.

            There are many, many metrics used to determine trend strength. CAPE is only a decent timing tool in hindsight. In real time, it tells you little to nothing about where the market is headed. Probabilistic forecasting would not call for using CAPE as it is an historically unreliable indicitor of market health and trend strength

            Liked by 1 person

            • Hence my new table in the SWR Google sheet, see part 28. At the real-time ATH, the way you compute it the risk of low SWRs is higher.
              Your way of thinking is a bit like musical chairs. Everything is good as long as the music plays. When it stops – and nobody knows when it stops – people will have a less than satisfactory retirement.
              But again, don’t get me wrong: I’m also generally optimistic on equities. I have essentially 100% equities in my portfolio and even a Bogle style scenario is not the end of the world if you are not too aggressive with your withdrawals. See part 16 of the SWR series.

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      • Oh and just for posterity’s sake (not that this is truly important) but 1982 was not a bottom in the market. 1982 was the very end part of a consolidation period in the market that had lasted nearly two decades, with many lower-lows touched within that consolidation box in the years prior to ’82 than were ever touched in 1982.

        At the back end of 1982 the S&P took off and continued a nearly multi-decade run of all time highs that would finally culminate in the dot-com crash.

        So I was not wrong in what I said. A new all time high in the stock market was in fact hit in late 1982, and the market never truly looked back from there, hitting many, many new all time highs for a period lasting around 17 years.

        Liked by 1 person

  4. One last thought then I’m off my (much too) high horse. That thought is this:

    1982 only looks like a bottom because we can now see the chart to the right of it. We know what happened. Now it LOOKS like the bottom. But at that point in time it wasn’t the bottom at all, it was the absolute top of the mountain. With many, many people saying “danger, danger”. But history shows that these peaks with devastating drops are exceptions, not the rule. Recency bias may very well be blinding us from seeing bigger historical truths. That when we break out of a 15 year consolidation box (as we just finally did in 2013), that the market can gain more than we’ve ever imagined. Its happened twice before in our history. History strongly suggests that we are currently in the midst of the third run,with many,many more all time highs yet to come.

    If you’re still listening, thanks! I truly enjoy this blog a lot but I strongly disagree that we will look back in hindsight and see today as a bad time to retire. I believe we are in the equalivalent of 1989, with 10-12 more long years of gains to come

    Liked by 1 person

      • Most of the video in the link I posted below is spent addressing valuations and why historically valuation multiples have made for very poor stock market forecasting. Valuations conversation starts at around the 12 minute mark. Its well worth watching.

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      • Here is Robert Shiller making the case for the potential for many more years of gains and explaining why CAPE ratio is not a reliable indicator in bull markets as well. Video is about two weeks old or so.

        Like

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