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Is the 4% safe withdrawal rate still valid for UK retirees - part 3?

  • Writer: Noel Watson
    Noel Watson
  • Jun 2
  • 5 min read

Updated: Jun 11

Introduction




Challenge Fourteen: Assumes perfect investor behaviour


We talked about the impact of costs on portfolio sustainability. Now, we need to discuss the effects of investor (mis)behaviour on retirement outcomes and investigate investor vs. investment returns. Investment returns are the returns that a given portfolio generates, while investor returns are those that the investor actually receives. The difference between investor and investment returns is sometimes known as the 'Behaviour Gap', and as you will see below, measuring this 'gap' can be tricky, and there is no agreement on what it might be.


The Behaviour Gap is caused by investor 'misbehaviour', with common misbehaviours including:


Many stories demonstrate the impact of investor misbehaviour. The problem is that often, it's hard to determine whether they are true! One such story is the infamous Fidelity investment survey, where Fidelity conducted an internal review of customer performance from 2003 to 2013 and determined that those with the best returns were "either dead or inactive." The problem is that no one has been able to verify that story!


Another story features legendary fund manager Peter Lynch and the supposed returns for those invested in his Magellan fund. From 1977 to 1990, Lynch returned a compound annual return of 29%, whereas the average investor in the fund made only 7%. Again, it seems hard to determine where this story came from!


That said, there is evidence to suggest that investors do underperform their investments.


Morningstar investor returns gap by US category
Morningstar investor returns gap by US category

"Examining the economic costs of aging, we find that, on average, investors with stronger aging effects earn about 3% lower risk-adjusted annual returns, and the performance differential is over 5% among older investors with large portfolios."




Challenge Fifteen: Being able to cope with drawdowns


Bengen’s logic assumes investors continue withdrawing money even as their portfolio balance drops in challenging markets. A nervous retiree is unlikely to allow this to happen. But what happens if your pot is depleted in the early years of retirement, yet things would have worked out fine in hindsight? For example, our 1920 retiree would see their portfolio balance reduce by almost 25% two years into retirement. Would they be confident to continue their retirement spending, even though history shows they would not have run out?


Investment drawdowns can be sharp and painful!
Investment drawdowns can be sharp and painful!


Positives


So far, we have only examined the potential challenges a retiree may encounter when using Bengen's logic. However, this approach has many positives.



It's easy to implement


This can only be a good thing, especially since our financial literacy tends to decline with age as mentioned above.


Financial literacy declines as we age.
Financial literacy declines as we age.

Bengen's approach doesn't require expensive and sophisticated modelling tools that can have a steep learning curve and might not always be intuitive to use, with many nuances that can catch the infrequent user.


Future income is known


Assuming a retiree's planning assumptions around longevity, market returns, and inflation are prudent, and they are fortunate enough not to experience investment and inflation in retirement (especially in the early years) that are worse than in historical datasets, they can be reasonably confident that they can withdraw an inflation-adjusted amount from their portfolio each year without worrying about running out of money. They don't need to adjust spending depending on how well the market has performed.


Does not require complicated ongoing monitoring


Other than checking the prevailing inflation rate on an annual basis, we do not need to worry about issues such as:



Conclusion


In these three articles, we have reviewed Bill Bengen's seminal work, which evaluated taking inflation-adjusted withdrawals from a portfolio over fixed timeframes. Bengen's work was instrumental in putting a framework around retirement withdrawal planning. Examples of common thinking at the time included:

  • The average annual portfolio return is approximately 7%. Therefore, I can withdraw 6-7% a year without fear of running out of money.

  • In retirement, you cannot afford to take the risk of being invested in the stock market and should instead be invested 100% in bonds.


While Bengen's work was considered groundbreaking at the time, given that retirement research has evolved since his initial publication, there is an argument that it should now be viewed more as an academic exercise rather than a practical tool for real-world retirement planning, one that looks good in theory but less so in practice.


In our next blog, we will examine Guyton-Klinger withdrawal rate guardrails, which aim to address the numerous challenges associated with Bengen's approach. The question is, does this method succeed, or does it introduce new problems......



Want to find out more?


If you want help with building a robust retirement plan, please get in touch.


About us


The team at Pyrford Financial Planning are highly qualified Independent Financial Advisers based in Weybridge, Surrey. We specialise in retirement planning and provide financial advice on pensions, investments, and inheritance tax.

Our office telephone number is 01932 645150.


Our office address is No 5, The Heights, Weybridge KT13 0NY.


Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.





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