What’s your retirement SAFEMAX Rate?
There are a myriad of solutions offered for retirees to help manage their finances and wealth during their golden years. With people living longer, the questions of ‘will it last?’ and ‘how much can I expect?’ are fuelling the proliferation of tools, calculators and apps. Meanwhile, we know that anxiety and stress about money spike during life’s transitions, of which retirement is a big one.
The solutions are generally quite simple. We have previously written about the Three Bucket Strategy and I would love to hear from any retirees we don’t know personally who follow the approach. That approach was devised by renowned U.S. financial strategist, Harold Evensky, in the 1980s, and its objective is to help construct a robust retirement portfolio that can ride out market fluctuations and provide steady and dependable income.
The Three Bucket Strategy offers a blueprint for retirees to maximise their financial assets and the chances for a stable retirement income long after retirement.
While the Three Bucket Strategy provides a very basic set of rules for portfolio management and rebalancing, it doesn’t answer a simpler question on the minds of many approaching retirement.
That question is: how much money can you safely withdraw from your savings each year without running out?
Enter the four per cent rule, a widely referenced guideline developed by now retired U.S. financial planner Bill Bengen in 1994 and later revised to 4.5 per cent and renamed the SAFEMAX rate for “the maximum ‘safe’ historical withdrawal rate”. So, what exactly is the SAFEMAX rate, and how does it work?
Origins of the SAFEMAX Rule
In 1994, Bill Bengen, a now retired certified financial planner with a B.S. (Bachelor of Science degree) from MIT in aeronautics and astronautics, and the co-author of Topics in Advanced Model Rocketry, published a groundbreaking study in the Journal of Financial Planning.
His goal was to determine a “safe withdrawal rate” – the percentage of retirement savings a person could withdraw annually with minimal risk of depleting their portfolio. After analysing historical market data from 1926 to 1990, including periods of economic turmoil like the Great Depression, Bengen concluded that a four per cent withdrawal rate, adjusted for inflation, was sustainable for a 30-year retirement in most scenarios. In other words, if a retiree had stuck strictly to the four per cent SAFEMAX rate at any time through history, they would not have run out of money in less than 30 years – no matter when they retired.
How the SAFEMAX Rule works
Please note I use ‘four per cent’ and ‘SAFEMAX’ interchangeably.
The four per cent or SAFEMAX rule is straightforward. A retiree withdraws four per cent of their portfolio in the first year of retirement. In subsequent years, they adjust the withdrawal amount for inflation to maintain purchasing power. For example, if someone retires with a $1 million portfolio, they will withdraw $40,000 in year one. If inflation is two per cent, the next year, they withdraw $40,800, and so on.
The rule assumes a balanced portfolio, typically split 50-60 per cent in stocks and 40-50 per cent in bonds. This mix aims to balance growth (from stocks) with stability (from bonds), helping the portfolio withstand market fluctuations. Bengen’s research, based on the traditional 60/40 portfolio, showed that this strategy allowed a portfolio to last at least 30 years in nearly all historical market conditions. You might consider the Three Bucket Strategy with some money invested in Private Credit.
Why it matters
The SAFEMAX rule aims to provide retirees with a predictable income distribution while reducing the risk of outliving savings. Its simplicity makes it accessible for everyone. By following the rule, retirees might avoid overly aggressive withdrawals that could deplete their funds or overly conservative ones that might limit their lifestyle.
Of course, understanding the rule’s favourable impact on portfolio and funding durability means retirees can also answer the question of how much they might ‘need’ in retirement. For example, if a couple would like to retire on $100,000 per year, dividing this number by four per cent, produces a capital balance of $2.5 million. According to Bengen, if you start your retirement with $2.5 million invested 60/40 in bonds/stocks, you can withdraw $100,000 in the first year indexed to inflation, and if the markets behave as they did between 1926 and 1990, you should be able to sustain a satisfactory income for 30 years with your portfolio growing sufficiently to accommodate your withdrawals.
At this juncture, it’s worth digging a bit deeper into Bengen’s findings and conclusions. In 2012, Bengen stated the four per cent guideline was intended as a “worst case scenario” for retirees in the United States, using a hypothetical example of someone who retired in 1968 at a stock market peak before a protracted bear market and high inflation through the 1970s. In that scenario, a four per cent withdrawal rate allowed the investor’s funds to last 30 years. Historically, Bengen says closer to seven per cent is an average safe withdrawal rate, and at other times, withdrawal rates up to 13 per cent have been feasible.
Therefore, it’s reasonable to assume some flexibility in the withdrawal rate during good years, accepting belts might need to be tightened a little during leaner years for markets.
Limitations and modern considerations
While the four per cent rule remains a popular benchmark, it’s not without criticism. Bengen’s study relied on historical U.S. market data, which may not reflect future performance, especially in periods of low bond yields or high market volatility or the impact of a modern conflict involving nuclear weapons. As Charlie Munger once observed, ‘if history was the key to investment success, the richest people in the world would be librarians.’
Understandably, some experts argue that a lower rate, like three per cent or 3.5 per cent, may be safer in today’s economic environment. Of course, the more you have accumulated before retirement, the easier it is to be flexible in what you withdraw while preserving a comfortable retirement.
Additionally, the rule assumes a fixed 30-year retirement and doesn’t account for individual factors like healthcare costs, unexpected expenses, or changes in lifestyle. Retirees with more flexible spending habits or those who incorporate other income sources, like Social Security or pensions, may need, or be able, to adjust the rule.
Bengen himself has acknowledged these limitations and emphasised the importance of stress-testing withdrawal plans against various market scenarios.
Practical tips
If you’re considering the four per cent rule, speak to a financial advisor who may recommend the following:
- Diversify investments: A balanced portfolio (see our articles on Private Credit) is key to weathering market ups and downs,
- Monitor inflation: Adjust withdrawals annually to maintain purchasing power,
- Remain flexible: Be prepared to reduce withdrawals during market downturns or supplement income with part-time work, a side-hustle or other sources, and
- Consult them to tailor the rule to your specific needs and circumstances.
I suggest you re-read the Three Bucket Strategy: Here.
Private credit
If you understand the four per cent rule, you will have gleaned that it leaves enough capital invested for the worst historical market declines to recover, while continuing with withdrawals. Of course, investors could withdraw more, or have less invested, if the annual returns were reliably higher than a 60/40 portfolio or experienced less volatility.
Hypothetically, a fund offering a 9.6 per cent return, paying income monthly and experiencing no negative months, would be very attractive to a retiree applying the SAFEMAX rule. While no fund can guarantee such an experience, and while past returns are not a reliable guide to future performance, that’s been the experience of the earliest investors in the wholesale-only Aura Private Credit Income Fund since inception. Once again, past performance is not a reliable indicator of future returns, so investors with an interest in yielding a return higher than the SAFEMAX rate might consider conducting due diligence on the private credit funds Montgomery offers investors in Australia and then speaking to their advisor.
A timeless framework?
Bill Bengen’s four per cent rule, while not a universal solution, provides a reasonable, if not reliable, starting point for retirees seeking to balance income needs with portfolio preservation. It may also help to answer the question ‘how much do I need?’ By combining the four per cent rule with prudent investment management, flexibility, and professional guidance, retirees might be able to use the rule to navigate the complexities of retirement with a little more confidence.
Investors and retirees can find more information about the Aura Private Credit Income Fund here.
Disclaimer
You should read the relevant Product Disclosure Statement (PDS) or Information Memorandum (IM) before deciding to acquire any investment products.
Past performance is not an indicator of future performance. Returns are not guaranteed and so the value of an investment may rise or fall.
This information is provided by Montgomery Investment Management Pty Ltd (ACN 139 161 701 | AFSL 354564) (Montgomery) as authorised distributor of the Aura Core Income Fund (ARSN 658 462 652) (Fund). As authorised distributor, Montgomery is entitled to earn distribution fees paid by the investment manager and may be issued equity in the investment manager or entities associated with the investment manager.
The Aura Core Income Fund (ARSN 658 462 652) (Fund) is issued by One Managed Investment Funds Limited (ACN 117 400 987 | AFSL 297042) (OMIFL) as responsible entity for the Fund. Aura Credit Holdings Pty Ltd (ACN 656 261 200) (ACH) is the investment manager of the Fund and operates as a Corporate Authorised Representative (CAR 1297296) of Aura Capital Pty Ltd (ACN 143 700 887 | AFSL 366230).
You should obtain and carefully consider the Product Disclosure Statement (PDS) and Target Market Determination (TMD) for the Aura Core Income Fund before making any decision about whether to acquire or continue to hold an interest in the Fund. Applications for units in the Fund can only be made through the online application form. The PDS, TMD, continuous disclosure notices and relevant application form may be obtained from www.oneinvestment.com.au/auracoreincomefund or from Montgomery.
The Aura Private Credit Income Fund is an unregistered managed investment scheme for wholesale clients only and is issued under an Information Memorandum by Aura Funds Management Pty Ltd (ABN 96 607 158 814, Authorised Representative No. 1233893 of Aura Capital Pty Ltd AFSL No. 366 230, ABN 48 143 700 887).
Any financial product advice given is of a general nature only. The information has been provided without taking into account the investment objectives, financial situation or needs of any particular investor. Therefore, before acting on the information contained in this report you should seek professional advice and consider whether the information is appropriate in light of your objectives, financial situation and needs.
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Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
He is also author of best-selling investment guide-book for the stock market, Value.able – how to value the best stocks and buy them for less than they are worth.
Roger appears regularly on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
