by Rob Bennett
Another of the dangers of the Old School retirement calculators is that they employ assumptions that leave little room for error, an odd way of going about business when constructing tools to help people plan retirements! The widely cited 4 Percent Rule assumes that retirees are okay with seeing their portfolio values reduced to zero over the course of 30 years. What if the retiree wants to know what safe withdrawal rate applies if he wants to leave at least 50 percent of his starting-date assets to his heirs? The old calculators do not provide a means for him to explore possibilities along these lines.
The Retirement Risk Evaluator does. The graphic below compares the safe withdrawal rate that applies for a retirement beginning at a time when the P/E10 value is 14 for retirees with four different demands re the lowest portfolio balance that will apply at Year 30:
Scenario One applies the standard assumption that the retiree is okay with seeing the portfolio value depleted to zero over the course of a 30-year retirement. Scenario Two shows the results that apply if the retiree insists on a Year-30 Portfolio Balance of at least 20 percent of the retirement starting-date portfolio balance. Scenario Three shows the results where at least 50 percent of the starting balance must remain. And Scenario Four shows the results where at least 100 percent of the starting balance must remain.
A demand that 100 percent of the portfolio balance remain at Year 30 reduces the safe withdrawal rate by less than one full percentage point! Insisting that your portfolio retain its value delays your retirement date, as would be expected. But the cost of insisting that a significant percentage of your starting-point portfolio value be retained or even that the entire starting-point portfolio value be retained is much less than the cost that is incurred by failing to take valuations into consideration. The conventional retirement planning guidance is failing to provide retirees with valuable information about the tradeoffs that come into play when putting together a retirement plan.
The calculator permits a more direct analysis of the relative significance of these two factors. Graphic 6 sets forth a side-by-side comparison of the reduction in the safe withdrawal rate that applies when the P/E10 level rises from 8 to 44 and the reduction in the safe withdrawal rate that applies when the P/E10 level is stable (at 8 ) and the retiree demands that 100 percent of his starting-point portfolio value remain in place at the end of 30 years rather than going along with the conventional assumption that the portfolio value may be reduced to zero:
The price paid for a huge swing in valuations (the difference between the Scenario One and the Scenario Two results) is stunningly great. But the price paid for demanding that the ending-point portfolio value be as great as the starting-point portfolio value (the difference between the Scenario Three and the Scenario Four results) is not terribly significant. I believe that the future of investing analysis is educating investors about the tradeoffs inherent in all investment decisions. The new calculator indicates that today’s general understanding of these tradeoffs is not well-formed. The good news, of course, is that this reality encourages us that we can achieve great progress in a short amount of time if we focus our energies on coming to a better understanding of the many investment analysis topics that remain a bit beyond our grasp today.