Is 5% really a safe draw rate at retirement?

Adrian Clayton

Advisors have deep insights into structuring their clients’ wealth to meet their retirement requirements. Considering the perilous state of markets over the past five years, we thought it worthwhile to test the widely held view that drawing 5% of capital at the end of a hard-working career would always lead to safe and happy retirement.

Cash over all the rolling years has less than a 25% probability of growing an investor’s capital base in real terms when drawing 5%. It only produces real returns of about 1.7%, so draw rates need to be low, no higher than this level, if cash is used as the retirement asset of choice.

In the shorter-term, the balanced portfolio’s inflation-beating prowess is just above 50%, but once past seven years, the numbers stack in the retirees’ favour and the odds shoot through 75%.

Clearly, capital is well-protected from inflation in a well-managed, balanced portfolio, even when drawing 5%. Although it is sound advice that the longer the investment time horizon, the greater the probability of achieving a desired return, is a “longterm” slam dunk.

The probability of achieving real returns while drawing 5% does not reach 100% – the max probability gets to 96%, so there have been times historically where a balanced portfolio over 15 years has retreated in real terms as 5% is drawn annually. A draw rate of 5% can be too high.

We assessed our data series and noticed that in 1968 when the market had high price/earnings and low dividend yields and was expensive, the subsequent 10year returns were negative in real terms to investors drawing 5%.

If planners want to know what the maximum draw-rate that would have been historically feasible to ensure a client’s capital remained intact with the knowledge that they could retire comfortably, they would need a 4.1% annual draw on the original capital base.

Adrian Clayton is the MD of Northstar Asset Management