Portfolio Income Strategies Back on Track
The ultra-low interest rates of the past decade produced a noticeable casualty: the 4% retirement withdrawal rule. In a nutshell, the rule says that a retiree who depends on income produced by an investment portfolio to replace working income can generally count on being able to withdraw 4% annually from the assets of an appropriately-allocated portfolio. This withdrawal rate is supposed to be sustainable in terms of retaining the principal and allowing for growth to keep up with inflation.
A key component of the allocation strategy to support a sustainable withdrawal rate is bond positions of varying durations, since bonds produce predictable cash flows while holding priority over equity in a company's capital structure and therefore typically presenting less risk than equities. When investment-grade bonds offer interest rates of 4-5% or higher, such bonds can support the traditional withdrawal rate. However, for over a decade until last year, the Federal Reserve held the federal funds rate near 0% to support recovery from the 2007-2008 financial crisis and the COVID-19 pandemic.
This led directly to much lower interest rates for bonds. In July of 2020, for instance, the rate on investment-grade, Aaa-rated bonds as measured by Moody's was as low as 2.01%. Retirement portfolio income withdrawal rates needed to be adjusted downward since bonds simply couldn't support the 4% withdrawal rate without excessively digging into principal, which would degrade the portfolio's ability to provide yield and inflation-hedging growth in subsequent years.
As of September 21st, 2023, however, the Aaa-rated bond interest rate sits at 5.21%. This normalization of interest rates is enabling retirees to revisit a more palatable portfolio income withdrawal rate of 4%, depending on individual circumstances and financial considerations. Appropriate withdrawal rates may vary widely for different people based on their financial goals, risk tolerance, and time horizon. In general, the healthier interest rates provide investors with more optionality as they develop a strategy for portfolio growth and cash flow requirements.
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- Tony Winkels is Managing Partner and Wealth Advisor at Fortis Wealth Management
