Retirement Funding and Portfolio Allocation

Open Access
Author:
Delanoy, Dana Nicole
Area of Honors:
Finance
Degree:
Bachelor of Science
Document Type:
Thesis
Thesis Supervisors:
  • Brian Spangler Davis, Thesis Supervisor
  • James Alan Miles, Honors Advisor
Keywords:
  • Retirement funding
  • Portfolio allocation
  • William Bengen
  • Safemax rate
  • 4% rule
Abstract:
The purpose of this thesis is to investigate the four percent rule that was introduced by William Bengen in 1994. Being that the finding was later popularized by the Trinity Study in 1998, Bengen himself deemed four percent the “Safemax”. Many critics of the four percent withdrawal rate have claimed that the study performed by Bengen may not apply in more recent years, due to an increase in life expectancy as well as a different economic state. Because of these critiques, many other economists have designed their own studies changing different factors to discover their own results, which have been outlined in this paper. This safe withdrawal rate is crucial to the success of a retiree in ensuring they do not run short of money before their death, but also allowing them to consume as much as they possibly can each year. I have performed my own simulation of a safe withdrawal rate, using a 5% withdrawal rate and returns of the S&P 500 and T-bonds from the years 1926-2012. However, in my study, I used portfolio allocations that change every 5 years of a retirees’ 35 year expected retirement, first gradually increasing stock exposure every five years, and then gradually increasing bond exposure every five years. What I discovered challenges the traditional belief that the shorter the time horizon, the less exposure a portfolio should have to stocks because of their higher risk. From my simulation, I can conclude that it is most beneficial to increase your stock exposure through the years, while decreasing your bond exposure. Bengen laid the foundation for a safe rate in 1994 but it is time to modernize his findings.