Some Moderate Thoughts About Safe Withdrawal Rates


 Valuation-Informed Indexing #363

By Rob Bennett

Buy-and-Holders and Valuation-Informed Indexers have some sharp differences on how to calculate the safe withdrawal rate (the percentage that a retiree can take out of his portfolio each year with virtual certainty that the portfolio will survive 30 years, presuming the stocks will continue in the future to perform at least somewhat as they always have in the past). The Buy-and-Holders say that the safe withdrawal rate is always 4 percent; it makes sense to believe that the safe withdrawal rate is a single number if you believe that the market is efficient. The Valuation-Informed Indexers believe that, since valuations affect long-term returns (as Shiller showed in 1981), the valuation level that applies at the time the retirement begins must be taken into consideration to perform the calculation accurately and the safe withdrawal rate thus may drop to as low as 1.6 percent (in 2000) and rise to as high as 9.0 percent (in 1982).

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I thought that in the interests of achieving a greater measure of comity with my Buy-and-Hold friends, it might be a good idea to advance some reasons why the two camps are not necessarily as far apart in their thinking as they sometimes appear to be. I came up with three reasons.

First, the safe withdrawal rate is a highly conservative number. The idea is to look at the worst-case scenario. While a calculation taking valuations into consideration really does produce a safe withdrawal rate of 1.6 percent for retirements that began at the height of the bubble, the fuller reality is that it would not be at all unreasonable for investors to plan retirements calling for withdrawal rates greater than the one that qualified as “safe” under the tough standard that applies pursuant to the conventional definition of the term.

The retirement calculator at my web site identified not just a “safe” withdrawal rate (the rate that has a 95 percent chance of working out, according to the historical return data) but also a “reasonably safe” withdrawal rate (the withdrawal rate that has an 80 percent chance of working out). In 2000, when the safe withdrawal rate was 1.6 percent, the reasonably safe withdrawal rate was 2.6 percent. Today, the safe withdrawal rate is 2.8 percent but the reasonably safe withdrawal rate is 3.4 percent.

There’s nothing “wrong” with an investor choosing to go with a retirement plan with only an 80 percent chance of working out rather than insisting on meeting the dictates of what constitutes “safe” according to most of the existing literature in the field. This is a judgment call that each investor must make for himself or herself. The job of those offering safe withdrawal rate calculations is to help investors to better inform their own choices, not to insist on the highest possible standards of retirement safety.

Second, investors might be notified that, if they elect to go with a weaker form of safety in their retirements than the ideal 95-percent-safe standard, there’s a good chance that they will learn early in their retirements if they are living through one of the return patterns that are likely to bring on retirement failure down the road a bit. It is retirements that take big hits in the early years that collapse, usually many years later. It is foolish to ignore bit hits because the retirements have not yet gone under; it is critical to pay attention to warning signs when there is still time to bring retirements up to a level of reasonable safety. But it should be reassuring for investors to know that, even retirements that are not developed to meet the highest safety standards, can become highly safe so long as they avoid for ten years or so the major hits that signal rocky waters ahead.

Third, at times when stock valuations are so high that reports of the accurately calculated safe withdrawal rate become depressing to aspiring retirees, it is usually possible to increase the safe withdrawal rate dramatically by moving a greater portion of one’s assets to non-stock asset classes. Most conventional safe-withdrawal-rate studies were developed in the 1990s, when stock prices were booming. It was fashionable at that time to suggest that even retirees should go with high stock allocations because the returns from stocks were viewed as being so much higher than the returns available from other asset classes. Calculations that take valuations into consideration tell a very different story.

At the top of the bubble, the safe withdrawal rate for an 80-percent stock portfolio was only 1.6 percent real. But Treasury Inflation-Protected Securities were at the time offering a guaranteed 30-year return of 4.0 percent real. That’s a safe withdrawal rate of 5.8 percent real! The safe withdrawal rate is larger than the return in the case of TIPS because the convention in safe-withdrawal-rate calculations is to assume that the portfolio value will be reduced to zero over the course of 30 year. It is smaller than the return in the case of a high-stock portfolio because heavy losses in the early years of a retirement can wipe out a counter-intuitively large amount of long-term gains and the odds of heavy losses taking place in the early years of a retirement are very high for retirements beginning at times of super-high valuations.

So lowering the stock allocation and increasing the TIPS allocation can increase the safe-withdrawal-rate dramatically. Many investors would not feel comfortable going with a 100 percent TIPS allocation even in the circumstances that applied in early 2000. But even a shift to a 50 percent TIPS allocation would have pushed the safe withdrawal rate up to 3 percent real. (and pushed the reasonably safe withdrawal rate up to 3.4 percent real). Investors are often shocked to hear that the safe withdrawal rate can drop to as low as 1.6 real (this truly is a hard-to-believe number when you consider that stocks earn an average long-term return of 6.5 percent real). It can come as a comfort for them to learn that they have the reasonably appealing option of increasing their TIPS allocation by 30 percent and thereby increasing their safe withdrawal rate by 1.4 percentage points (or by 1.8 percentage points if they are can live with a 20 percent chance that the retirement will fail).

The purpose of including valuation adjustments in safe-withdrawal-rate calculations is not to shock or depress investors. It is to inform them of the realities they face when seeking to put together a prudent retirement plan at a time of high valuations. Ignoring valuations is a reckless, head-in-the-sand approach to retirement planning, in my assessment. But I have seen many investors overreact to the story told by the valuation-adjusted numbers. Investors should be reassured that there is usually a way to construct at least a reasonably safe retirement plan even at times when stock prices have unfortunately gone through the roof.

Rob’s bio is here.

Updated on

Rob Bennett’s A Rich Life blog aims to put the “personal” back into “personal finance” - he focuses on the role played by emotion in saving and investing decisions. Rob developed the Passion Saving approach to money management; Passion Savers save not to finance their old-age retirements but to enjoy more freedom and opportunity in their 20s, 30s, 40s, and 50s - because they pursue saving goals over which they feel a more intense personal concern, they are more motivated to save effectively. He also developed the Valuation-Informed Indexing investing strategy, a strategy that combines the most powerful insights of Vanguard Founder John Bogle and Yale Professsor Robert Shiller in a simple approach offering higher returns at greatly diminished risk. Tom Gardner, co-founder of the Motley Fool web site, said of Rob’s work: “The elegant simplicty of his ideas warms the heart and startles the brain.”
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  1. Today we yet another example of hypocrisy. On your website, you describe posts that differ fro your opinion as “abusive”, yet you call people “goons” and “con-men” and tell them that they are going to prison. You also tell people that it is a felony for anyone to block your posts, yet not a felony when you do it.

  2. The most ironic thing is that we are talking about investing for retirement and your plan for retirement is not based on investing, but in receiving a $500 million settlement payment (which is pure fantasy).

  3. And there you go again….just proving my point.

    The number 1 cause of retirement failure is inadequate savings (which has been your problem).

    Stop blaming everyone and everything else.

  4. I have focused my writing efforts on investing issues in recent years. But I wrote extensively about saving in earlier days.

    I don’t want to see Buy-and-Hold cause even a single failed retirement. If it is true that the Buy-and-Hold retirement studies do not contain valuation adjustments, I think it is fair to say that the number is going to end up being a lot bigger than “one.” How is that a good thing? The studies should be corrected.

    Now —

    Let’s say that the authors of the studies are suffering so much cognitive dissonance that they cannot bear to acknowledge that their studies are in error. I believe that cognitive dissonance is a real thing. So I believe that it is possible that the authors of the studies are able to rationalize to themselves not including valuation adjustments in them. What then?

    In that case, the authors of the studies should at a bare minimum point out in the studies that there is 36 years of peer-reviewed research showing that valuations affect the result and let people know that there are people who have calculated what the safe withdrawal rate is in the event that valuations affect the result. Then the people reading the studies can decide for themselves whether they want to follow the Buy-and-Hold numbers of the Valuation-Informed Indexing numbers. It seems to me that it is a lot better to let the readers of the studies decide which sort of study they are going to follow or whether they want to adopt some middle-ground position.

    It seems to me that it is the worst of all worlds not to even let study readers know that there is an academically respected alternative to the Buy-and-Hold numbers. If the retirements really do fail, the people who used the studies to plan their retirements are going to be upset. They are going to be doubly upset when they learn that there were people who warned the authors of the Buy-and-Hold studies that valuation adjustments were needed and that the authors of the studies didn’t even bother to let the readers of their studies know about the issue.

    These are my sincere thoughts re this terribly important matter in any event, old friend.


  5. Scan back the last two years on your boards. Nothing about savings. Scan this site. Ditto. You continue to classify buy and hold as the biggest cause of failed retirements (a lie).

    Also, to set the record straight, it was not you that made the motley fool board successful. Saw the old history on that claim and where you were set straight. The prison crap is just your fantasy.

  6. I wrote an entire book (Passion Saving: The Path to Plentiful Free Time and Soul-Satisfying Work) on how to save effectively, Sammy. There are scores of articles on this topic at my web site. It was my posts on saving that built the Retire Early board at Motley Fool into that site’s most successful board.

    In those days, I never wrote about investing. That was a mistake. People who learn how to save effectively need someday to learn how to invest effectively. One leads to the other.

    I derived more personal pleasure out of writing about saving than I have writing about investing. But it’s not possible to do a good job of helping people learn how to achieve financial freedom early in life without addressing both subjects.

    And, just to be clear, I have always OPPOSED the Goonish behavior that lands people in prison cells. I write about it when I see it take place before me because I want to bring it to a stop. It hurts all of us. If we all spoke up about it when we saw it, we would see less of it. That’s my sincere take re the matter, in any event.

    I wish you all good things, old friend.


  7. I don’t recall seeing even one column on this site or your own site that address lack of sufficient savings, yet you seem to spend significant periods of time discussing goons, prison sentences, etc. Don’t you think that is really screwed up?

  8. It is just a fact, Rob. It has been documented many times that the #1 cause of a failed retirement is lack of proper savings. It is not even debatable. You obviously don’t like that because it has also been your problem. No one forced you to stop working at such a young age with only $400k in savings, while still raising a family.

  9. We disagree, Sammy.

    But I am grateful to you for taking time out of your day to share your thoughts with others who can read about both positions and thereby come to better informed decisions of their own.

    My best wishes to you.


  10. Since the 4% rate has always worked, I would be telling the drunk guy that the real problem, other than being drunk, is that he didn’t save enough.

    Just like the drunk, you have a hard time accepting what your real problem is. It is time for you to sober up and realize that you have the same issue that most American’s have, which is inadequate savings.

  11. You are correct that there has never been a 30-year period in which a 4 percent withdrawal rate has not worked, Sammy But that reality doesn’t tell us that a 4 percent withdrawal is safe for retirements beginning at any possible valuation level. In a world in which valuations affect long-term returns, you need to take valuations into consideration when identifying the safe withdrawal rate. Take valuations into consideration and the number you get for people who retired at the top of the bubble is 1.6 percent real. That’s nothing close to 4 percent.

    Say that you had a friend who was an alcoholic and you were trying to persuade him to take a cab home from a party where he got drunk. Say that he told you that he had driven home drunk on three prior occasions and had been hospitalized in each case but was still alive and that, thus, it was safe to drive drunk. Would that persuade you? Huh? The fact that he was hospitalized each time he drove drunk tells us that driving drunk is a high-risk activity, not a safe one.

    So it is with retiring at a time of high valuations and using a 4 percent withdrawal rate. There have been three occasions prior to the current era in which people could have done this. In each of the three cases, retirees who used a 4 percent withdrawal would have seen a wipe-out of most of their retirement portfolios but would have had a few dollars remaining in their portfolios at the end of 30 years. How is it safe to have a retirement portfolio reduced to a few dollars? It’s not. It’s high-risk. The phrases “high-risk” and “safe” are not synonyms.

    4 percent is of course safe at moderate or low valuation levels, just as it is safe to drive when one is not drunk. But driving drunk is never safe. And retiring at a time of high valuations with a 4 percent withdrawal rate is never safe. It is possible that such a retirement will survive. That has happened. But the retiree doesn’t know in advance what sort of return sequence is going to come up. Since he doesn’t know, he should be choosing a withdrawal rate that is at least reasonably safe, not one that is extremely high risk. We certainly should not be encouraging him to use the extremely risky withdrawal rate by assuring him that it is safe. Again — Huh?

    This is my sincere take re these terribly important matters, in any event. I naturally wish you the best of luck in all your future life endeavors, my long-time Buy-and-Hold friend.


  12. There has never been a 30 year period in which a 4% withdrawal rate has not worked. To focus on this issue, however, is wrong if we are trying to determine the primary reason retirement plans fail. The primary cause is lack of sufficient savings. Given that this is your biggest mistake, it is not surprising that you attempt to avoid this topic and look to blame someone or something else.

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