Safe Withdrawal Rates, Investment Returns, and Minimizing Your Expenses

The topic of safe withdrawal rates is critically important to retirees. Earlier this week we talked about retirement withdrawal strategies, but that was a discussion of how to access your money rather than how much money you can safely distribute per year.

What’s a “safe” withdrawal rate?

While there are no easy answers, the stakes couldn’t be higher. If you pick a number that’s too high, you’ll run out of money before you run out of time. If, on the other hand, you pick a number that’s too low, you’ll wind up leading an unnecessarily ascetic lifestyle, ultimately dying with a huge pile of cash.

If you ask around you’re get a variety of answers. By far the most common one that you’ll run across is the 4% rule. In short, this rule holds that you can “safely” withdraw an inflation-adjusted 4% of your nest egg from the year that you retire onward.

Of course, the topic of safe withdrawal rates is very complex, and the reality is that “it depends.” In other words, it depends on your time horizon, the composition of your investment portfolio, whether or not you retire into a collapsing stock market, and so on.

The only thing that we can say for certain is that higher returns will better support whatever withdrawal rate you settle on. But how can you boost your returns without appreciably increasing your risk? Well… What would you say if I told you that the average investor can easily increase their returns by 1% per year while taking on virtually no additional risk?

Maximizing returns by minimizing expenses

Sounds too good to be true, right? After all, 1% can make a huge difference in the size of your nest egg, but there is (typically) no such thing as a free lunch. Well, consider the following.

The average expense ratio for actively managed mutual funds is in the neighborhood of 1.5%. On top of that, numerous studies have revealed that the majority of actively managed funds underperform their target indices, sometimes by a lot. Why? Mostly because of the added expense of the fund manager.

In contrast, index mutual funds (or equivalent ETFs) have dirt cheap expense ratios (often in the 0.1-0.2% range), thereby allowing them to essentially match the returns of their target indices.

So how can you increase your returns without taking on more risk? Simple. Keep a close eye on expenses. Instead of overpaying for underperformance, focus on constructing a portfolio with using high quality, low cost investment vehicles. Of course, this is often easier said than done.

For example, you might have a fee-laden 401(k) with limited options. Sure, you could lobby your employer for changes, but they might resist. In that case, your best option might be to simply contribute enough to get your employer’s match and then focus on investing outside of your 401(k), where you’ll have complete control.

12 Responses to “Safe Withdrawal Rates, Investment Returns, and Minimizing Your Expenses”

  1. Anonymous

    @Rob – Well said. Adding to this, SWR discussion, I think it’s important for aspiring retirees to think of their situation in terms of their net worth-to-expenses multiple. In essence, a 4% SWR equates to a 25x multiple, a 3% SWR equates to a 33x multiple. I’ve found that more people think in terms of this multiple rather than the SWR percentage.

    When someone is facing the decision (whether of their own design or that of another’s) to retire, knowing the relationship between SWR and net worth-to-expenses is critical. This multiple is a function of your net worth (hard to change) and expenses (much easier to change than net worth).

  2. Anonymous

    I never really understood the point of the SWR.

    The point is to be able to plan effectively, Evan.

    Say that you have $1 million and are 60 years old and are interested in the idea of early retirement. Say that you need $70,000 per year to live the life you want to be able to live in retirement. Say that you have read that stocks provide an average long-term return of close to 7 percent. Going by that, you might hand in the resignation. A 7 percent return gives you $70,000 per year, which is what you need.

    The Old School SWR studies (to their credit) showed that it doesn’t work this way. Because the 7 percent return is an average and does not apply each and every year, the only way to know whether you have enough to retire or not is to look at the worst-case scenario of the possible returns sequences and see whether you would be okay in those circumstances. This is where the infamous 4 percent rule comes from. A 4 percent withdrawal worked in the worst-case returns sequence that we have seen in the historical record.

    I view the Old School studies as a huge advance. It was not too long ago that Peter Lynch was telling aspiring retirees that they could count on a plan calling for a 7 percent withdrawal working out. Scott Burns pointed out to Lynch that the Old School SWR research proved him wrong and Lynch apologized for the error.

    I believe that we now face a situation where the Old School SWR authors themselves need to acknowledge an error. The Old School studies do not adjust for the valuation level that applies on the day the retirement begins. it is true that a 4 percent withdrawal is safe for retirements that begin at times of moderate valuations. But at times of high valuations, the SWR can drop to 2 percent and, at times of low valuations, it can rise to as high as 9 percent.

    If retirees don’t invest in stocks, they don’t need SWR analysis. If you are invested in inflation-protected bonds, you know exactly how much your portfolio is going to throw off and can count of living on that amount for your entire retirement. It is the volatility of stocks that causes the confusion and the planning difficulty. The purpose of SWR analysis is to make retirement planning efforts more effective.

    It is my strongly held view that the Old School studies fail to do what they set out to do. These are dangerous studies because they give retirees a false confidence that things that are very unlikely to happen are almost certain to happen. But I think that the idea of SWR analysis is a wonderful advance. Telling people that 4 percent is always safe is wrong but it is whole big bunch better than telling people that 7 percent is always safe. So I do think it can fairly be said that things are moving in the right direction. We are learning more about the realities of stock investing and retirement planning over time and that is of course a good thing.


  3. Anonymous

    I never really understood the point of the SWR. Your withdrawal rate seems to be a function of what you need to live.

    If you need $100K to live does it matter whether that is 3 or 4% of your investment portfolio?

  4. Anonymous

    I agree, 4% is a safe withdrawal rate. One of my editors, who retired at 45 earns about $140,000/yr in income based off a 4% risk free rate of return.

    Any more, and people are kidding themselves over the long run.

  5. Anonymous

    @Nickel & Rosa – The ‘it depends’ is so right. As for what a safe withdrawal rate might be, it CAN be calculated using monte carlo analysis.

    We have embedded this in our web application, but we are partnered with Money Tree Software ( They have a tool where you basically input your retirement assets, set your likely spending bumpers (90% to 125% of projected income), your portfolio’s historical standard deviation rate, and the number of years you plan to draw down the portfolio. It spits out a percentage likelihood of your nest egg surviving the variations in the market, inflation, and spending.

    Also, I see Rob has added his SWR calculator as well. If someone is nearing retirement and concerned about withdrawal rates, I highly suggest using a monte carlo analysis to figure it all out. Often the analysis can tell you if your investment allocation is too aggressive or conservative as well.

    @Dan – funny you mention purgatory for 1 and 2 star funds. A study completed several years back found that 1 and 2 star funds were unlikely to make it out of the 1 and 2 star categories. In other words, avoid them because purgatory actually does exist for these poor souls.

  6. Anonymous

    I am the person who discovered the analytical errors made in the Old School SWR studies (this was back in May 2002). The old studies fail to include an adjustment for the valuation level that applies on the day the retirement begins.

    Calculating the number correctly makes a big difference. The Old School studies claim that the SWR is always 4 percent for a high-stock-allocation portfolio. The New School studies show that the SWR can drop to 2 percent at times of high valuations and rise to 9 percent at times of low valuations. There will be millions of middle-class Americans who will suffer failed retirements because of the demonstrably false claim made in the Old School studies (not one of these studies has been corrected in the seven years since the errors in them were publicly revealed).

    John Walter Russell and I co-developed the only accurate SWR calculator available today on the internet, The Retirement Risk Evaluator. It puts the SWR for those retiring today with a high stock allocation at 4.1 percent.


  7. Anonymous

    Nickel, my mom & her husband are retired and I know they consider *no* withdrawal rate safe – considering the high cost of assisted living and nursing home care for the very last years of life, they are living only on the interest/dividends and their current cash flow (pension – neither is drawing SS yet).

    So I wonder – you gave the 4% withdrawal rule of thumb. Would you follow the 4% rule, yourself? Or are you intending to have a nest egg you don’t touch until late in retirement.

  8. Sorry, to me “high quality” funds are low cost index funds (mutual fund or ETF) from major, well-respected mutual fund families. I’m partial to Vanguard, but also have some money in Fidelity index funds with rock bottom expense ratios.

    I intentionally tried not to get too specific, because what’s right for one person could be totally wrong for another (allocation-wise). If you’re looking for a great read on asset allocation to help you narrow down your choices, I recommend The Intelligent Asset Allocator by William Bernstein.

  9. Anonymous

    In the paragraph before, he mentions index funds and ETFs. A high quality fund would be a liquid ETF with low expenses. For instance, the two most popular emerging market ETFs are EEM and VWO. EEM has a 72bps expense, while VWO is at 20bps, per Yahoo Finance. The high quality fund here would be VWO.

    And he’s right about small changes in return making a large difference in your nest egg. I wrote a post about how big the difference can be:

  10. Anonymous


    Points for addressing the mutual fund management fee issue. But you used the adjectives “high quality” and “low cost” to describe funds we should by. What, pray tell, is a high quality fund? Today’s 4 and 5 star rated funds could be tomorrows dogs. Does 1 or 2 stars sentence a fund to permanent mutual fund pergatory?

    Sorry if I seem a bit demanding, but the articles that mean the most to me (and keep me reading) are actionable plans. And I can’t take action if I have no idea what a high-quality fund is.

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