CKS White Paper in the Spotlight: Low Bond Yields and Safe Portfolio Withdrawal Rates

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CKS White Paper in the Spotlight: Low Bond Yields and Safe Portfolio Withdrawal Rates

Here we take a look into yields on government bonds and the impact it can have on you – the retiree. Keep your retirement finances safe with CKS Summit Group.

Executive Summary

Yields on government bonds are well below historical averages. These low yields will have a significant impact for retirees, who tend to invest heavily in bonds, because portfolio returns in the earliest years of retirement have a larger impact on the likelihood that a retirement income strategy will succeed than returns later in retirement; this is known as sequence risk.

The majority of research on sustainable withdrawal strategies has used a stochastic (Monte Carlo) simulation process based on long-term averages, where the expected return of an asset class is the same for each year of the simulation. While this approach is reasonable when markets are near long-term averages, we believe it is less useful when there is a significant and sustained deviation such as the current low bond yield market.

In this paper we introduce a model that takes into account current bond yields and allows them to “drift” toward a higher value during retirement using an auto regressive model based primarily on historical relationships between asset classes. This approach can better replicate the actual bond returns a current or near retiree can expect during retirement both now and in the future.

Using this model, we find a significant reduction in “safe” initial withdrawal rates, with a 4% initial real withdrawal rate having approximately a 50% probability of success over a 30-year period.

We find a retiree who wants a 90% probability of achieving a retirement income goal with a 30-year time horizon and a 40% equity portfolio would only have an initial withdrawal rate of 2.8%. Such a low withdrawal rate would require 42.9% more savings if the retiree wanted to pull the same dollar value
out of the portfolio annually as he or she would get with a 4% withdrawal rate from a smaller portfolio.