What Is a Drawdown Percentage?
A drawdown percentage is the portion of a retirement account that a retiree withdraws each year. If the drawdown percentage is too high, the retiree will outlive her savings and struggle financially at the end of her life. If the drawdown percentage is too low, the retiree will die with money left over. Many people wish to spend most or all of the money they’ve worked so hard to earn and invest during their lifetimes. Others want to make sure they leave an inheritance for their spouse, children or charities they support.
Understanding Drawdown Percentage
Drawdown percentages can be difficult for individuals or couples to calculate accurately. Many financial experts find that it can be easy to over or under calculate how much money one truly needs to live on through retirement. To combat the difficulty in determining how much you need to live on annual through retirement, a common suggestion for the ideal drawdown percentage is to take 4 percent of principal annually, adjusted for inflation. The 4 percent rule is supposed to maximize one’s chances of having enough money to last through to the end of one's life and is based on a 1994 study by past financial planner William Bengen. His study used stock mark data and average investment return to determine that 4 percent was the highest percentage that an individual could take in order to have their retirement money last 30 years, assuming they had invested at least 50 percent of their savings in stocks. More specifically, a drawdown percentage of 4 percent is based on the historical investment performance of a portfolio made up of 50% bonds and 50% stocks, and historical inflation rates. It is expected to ensure that the retiree’s nest egg lasts a minimum of 33 years and a maximum of 50-plus years.
Limitations of the Drawdown Percentage
While the 4 percent historical drawdown percentage can be a helpful guide, it may not be entirely accurate for today’s retirees. For example, critics of the 4 percent drawdown percentage say many people won’t experience 33 years of retirement because they will work beyond age 65 and/or because of poor health and point out that overall market performance has changed since the rule’s development in 1994. Usually, the best way to calculate the drawdown percentage for your own nest egg is to consult an independent financial planner who can look at your age, your financial needs, and your portfolio to determine a more precise percentage.