The Sustainable Draw Rates Study

June 11, 2019
Written by Matthew White, CFA®, Investment Analyst


In part three of the Sustainable Draw Rates Study, we examine results by historical stress testing and reach our conclusion.

Link to Part One

Link to Part Two

Probability of Success Across Multiple Time Horizons

We can conclude that stating portfolios consisting only of stocks are the optimal solution for investors to achieve their goals is incorrect. Rather, adding stocks is useful to improving probabilities of success for investors obtaining distributions from their portfolios – up to a point. This improvement is limited to approximately 70% stock portfolios when investors have access to high-quality, low-correlated non-traditional investments to provide diversity in their portfolios.

However, in absence of access or the ability to evaluate such non-traditional investments, it is likely true that investors seeking to improve their probability of success are best off allocating as much of their portfolio to stocks as they can behaviorally manage. This may explain the existence of all stocks portfolios which we come across from time to time from outside investors.

Historical Stress-Testing

Before concluding our study, we inquired whether our rejection of the hypothesis that an all stocks portfolio is best suited to obtain investor goals is validated by the historical record. Thus, we built a simulation similar to the one we described earlier, but used historical returns and volatility figures for our portfolio allocations. The results add a few caveats to our findings:

  1. History informs us that incrementally adding stocks provides a higher probability of success, though the value-add of stocks ceases somewhere between 40-50% of portfolio value (vs. 70% that estimates from our current environment imply).
  2. The addition of non-traditional assets do not increase the probability of success to the same degree that the current environment dictates. However, they do allow higher probabilities of success at lower stock exposure levels, indicating they would have permitted investors to obtain their goals with lower volatility.
  3. In the historical environment, an all bonds portfolio was able to sustain a 5% real draw rate out to 30 years with a 70% probability of success. This is in stark contrast to a 6% probability of success for an all bonds portfolio over the same time period using current estimates.

Historical Probability of Success

Beyond confirming our current findings on portfolio outcomes, these historical estimates seem to reinforce that the shift in secular interest rates over the past few decades have placed an entire generation of investors in a new paradigm of portfolio construction than the one which preceded them. Indeed, past performance is no indicator of future results.

  While we have laid out a mathematical framework that suggests addition of stocks to a portfolio improves potential outcomes, we do not surmise that every investor should increase their allocation to stocks. Humans are not rational creatures, and are subject to emotional reactions, particularly during times of market duress, which can cause us to deviate from our plans; however well thought out they may be. Specifically, investors with higher allocations to stocks are subject to additional volatility in their portfolios and may be more susceptible to behavioral reactions that could sabotage a portfolio’s long-term projected outcomes.

Ultimately, the best allocation for an investor is one that maximizes their probability of obtaining their goal while constraining risk – meaning they are likely to stick with their portfolio through good and bad times.  Defining a palatable level of risk is no small task and is outside the scope of this study. However, a starting point for investors is to have candid conversations with an experienced advisor or counselor who can assist them with establishing an “outside view” of their emotional or organizational tolerance for short term changes in the value of their portfolios. Once a comfort level of tolerable risk is established, our study concludes that investors should seek to maximize their potential return within their tolerance by diversifying into higher returning assets.


The All Stocks portfolio is assumed to be 38% Large Cap US, 12% Small Cap US, 30% International Developed, 20% Emerging Markets. The 50/50 Stocks Bonds portfolio is assumed to be previously described stock mix and 50% Barclays Aggregate.

Testing is carried out with 2,000 simulations of potential paths beginning with a $1,000,000 portfolio and a 5% draw rate that increases with a 2.2% inflation value each year. In addition to the cash outflow, an annual cost-to-access is assumed to be drawn from the portfolio as a % of recent assets. This is to capture the differing costs that various asset classes incur. Essentially, this implies that managers will exactly earn the market return for their asset class before expenses and will exactly underperform their market on a net basis after fees. The purpose here is to be conservative in estimates of value-add from non-traditional asset classes.

We assume a 7 BP cost-to-access stocks and bonds based on our Beta Portfolios implementation schedule. We do not assign a cost-to-access on Style Premia and Life Settlements as both estimates are round, net-of-fee, future expectations on the strategies. The cost-to-access for other asset classes are based on vehicles used.

Based on our 2018 Capital Markets Assumptions study and the above cost-to-access deductions, we summarize the inputs into the Monte-Carlo analysis.

Our historical stress-testing was based on returns going back to 1926 for asset classes that we could obtain them for, and back to the inception of a proxy index or market access vehicle for remaining asset classes. For more information on our historical data and methodology, please contact us.