If You Get the Safe Withdrawal Rate Wrong, You Get Everything Wrong

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The safe withdrawal rate is 4 percent. You hear Buy-and-Holders say that all the time. The idea is that a retiree can count on being able to withdraw 4 percent of his portfolio value ($40,000 from a $1 million portfolio) to live on each year for 30 years.

The number was developed by looking at historical returns. A 4 percent withdrawal would have worked in all the 30-year return sequences available in the historical record.

Safe Withdrawal Rate Changes With Changes In Valuation Levels

I don’t buy it. Shiller’s Nobel-prize-winning research shows that valuations affect long-term returns. If that’s so, it’s a logical impossibility that the safe withdrawal rate is the same number for retirements beginning at different validation levels.

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If Shiller’s research is legitimate research, the safe withdrawal rate must change with changes in valuation levels. Do the math and you learn that the safe withdrawal rate is 1.6 percent when stocks are priced as they were in 2000 and 9.0 percent when stocks are priced as they were in 1982. That’s a big difference from it being 4.0 percent at all times.

I have persuaded a good number of people of the error, including a few big-name experts. But there are many people who reject what I say out of hand. I have been banned at all sorts of discussion boards and blogs for saying what I say about safe withdrawal rates and related issues. This issue is not complicated. Why is it so contentious?

The most important clue I have for solving that one is the history of my own thinking on these issues. I put forward a post at a Motley Fool discussion board on the morning of May 13, 2002, saying that the safe withdrawal rate is not the same at all valuation levels. Some community members responded with effusive praise, others with harsh criticism.

That itself suggests that I was hitting at something important. But, looking back, the strangest thing about the experience was my own mindset about the connection between safe withdrawal rates and stock investing in general.

I thought that the 4 percent rule was wrong. I wouldn’t have dared to advance that post if I had not been confident on that point; a lot of the people who participated at this board were making use of the 4 percent rule to craft their early retirement plans. But I was a Buy-and-Holder myself at that time. I am not a Buy-and-Holder today.

I believe that market timing is essential for all investors. But I was a Buy-and-Holder on the morning of May 13, 2002. I look back now and ask: How could I possibly have seen the error in the safe withdrawal rate claims so clearly and still have believed that market timing is not always required?

Humans are capable of holding self-contradictory beliefs. We’re not logic processing machines, We pick up one belief from one place and another from another place and, for so long as they both check out, we continue to believe in both of them. It is only if we are forced to examine the two beliefs closely that we might come to see that a belief in one makes a belief in the other a logical impossibility.

Engaging In Market Timing

I believed that the 4 percent rule was wrong because of something I had read in one of John Bogle’s books. Bogle said that reversion to the mean of stock prices is an “iron law” of stock investing. If that’s so, the odds of seeing the sorts of returns that cause a retirement plan to go bust are higher for a retirement that begins at a time of high valuations. So the safe withdrawal rate has to be lower.

I saw that on the morning of May 13, 2002. What I didn’t see at that time is that, if what Bogle said is so, market timing must work and the Buy-and-Hold admonition to avoid it is dangerous. If stock prices revert to the mean, stocks are more risky when prices are high.


If stocks are more risky at some times than they are at others, investors who want to keep their risk profile constant MUST engage in market timing. There is no other way to achieve that goal.

The safe withdrawal rate is a risk assessment tool. To calculate the number properly, one must understand how stock investing risk works. There was a time when it was widely believed that stock investing risk is constant – that the market is efficient. Shiller discredited that idea.

So we (at least those of us who believe that Shiller’s research is legitimate) understand that stock investing risk is variable, that long-term market timing always works (short-term timing really doesn’t work) and is always required for those seeking to keep their risk profile constant.

It amazes me today that I didn’t understand all that on the morning of May 13, 2002. It seems so clear to me today. But the reality is that I really didn’t get it. To get safe withdrawal rates right, you have to understand how stock investing works.

And, if you understand stock investing risk, you understand why market timing (considering price when setting your stock allocation) is so essential. It was by seeing the error in the Buy-and-Hold retirement studies that I came to see that the idea that market timing doesn’t work is the product of a mistaken understanding of how stock investing works that was exposed by Shiller’s research.

Rob’s bio is here.