A retirement plan is usually established to ensure that you live seamlessly in retirement. A typical retirement plan is good-looking and would always give you images of a blissful life in retirement. However, as we’ve seen with many seniors around, things don’t turn out this way.
The problem is a substantial part of a typical retirement plan is based off some financial theories – theories that have to be true for the plan to work out perfectly. So, in an event that any of the theories fails to be true, the entire retirement plan is thrown off balance – which is often the case in the real world.
The Safe Withdrawal Rate – SWR – theory is one of the retirement theories that experts discuss regularly.
Here are three realties about it that should make any retirement investor regard SWRs less.
1. SWR calculation is based on assumptions
In general, SWRs are calculated based on assumptions. For instance, the current 4% drawdown rule was arrived at by studying the actual historical stock and bond returns from 1926 through 1995. In other words, for the 4% rule to be efficient for a (would-be) retiree, near historical return rates must be maintained throughout the lifetime of the retiree.
If, on the other hand, we decide to project into the future to determine a safe drawdown, the drawdown we’d arrive at is still at the mercy of the asset return rates that we use. But, in reality, we can’t be sure that historical trends would hold in future.
In addition, as we’ve seen many times with analysts predicting wrongly, we can’t put all of our eggs in what we believe would happen in future – because it’s only an expectation.
Experts are now saying that a 3% drawdown is more feasible considering the current economic situations. Their argument is that assets are generally expensive at present and as such, there’re limited growth chances.
While that could be true and, possibly, safer, the truth of the matter is it is still based on assumptions that return rates would remain at certain levels – which could turn out to be wrong in reality.
Long story short, if the actual returns in future deviate (reduce) from the return rates that are used, a retiree is exposed to the risk of outliving his/her savings.
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2. The SWR theory is dependent on inflation rate
Another part where the SWR theory misleads us is that it assumes a unified inflation expectation. But, in reality, it doesn’t seem like the relatively constant historical inflation rate can be maintained in the future.
If nothing else, the ever-rising US debt levels give no assurance that inflation rate will remain constant going forward. Moreover, just as in the case of return rate expectations, inflation rate expectations are nothing more than just expectations and as such, should not be thought of as perfect.
3. The SWR hypothesis isn’t humane
Here is the typical SWR story: withdraw a certain portion of your retirement saving every year for, say, thirty years and hope to pass on after those thirty years. That, to me, sounds like the dumbest plan to have. First, it means that if you live for forty years after retiring, you’ve already planned to live, at least, the last ten years of your life in financial turbulence. I bet you don’t want to end up that way.
Second, by recommending that you should withdraw your saving gradually, it assumes that you don’t have offspring for whom you’d need to leave any inheritance. In the real world, however, that is not true for most people. Plus, leaving something for one’s offspring to inherit is the dream of every parent. This, again, shows that the SWR hypothesis doesn’t connect with the human nature
Planning for your retirement is a real life thing
The earlier everyone comes to term with this reality, the higher the chances that people will have a decent life in retirement. Since one coat cannot fit everybody, there is no chance that setting a standard SWR would be perfect for everyone.
The takeaway from above is that there is no retirement theory that can take the place of traditional retirement maxims such as save more, protect the downside diversifying and invest in income-generating assets.