The safe withdrawal rate is not always the same number. The 4 percent rule makes no sense. Those of us who follow the peer-reviewed research have known this for 42 years. Once Shiller published his research showing that valuations affect long-term returns, it was clear to everyone that the safe withdrawal rate is a number that changes with changes in valuations.
It’s clear enough. But it’s also controversial. It’s clear in the way that it’s clear that smoking causes cancer and that driving drunk is dangerous and that one should pay attention to red flags before getting romantically involved with the wrong person. We humans know that some things are bad for us but we elect to do them anyway because there’s something about the way that they make us feel that we like.
The 4 Percent Rule Makes No Sense
There’s one big flaw to the idea of using peer-reviewed research to guide one’s investing decisions. There’s never been any research supporting Get Rich Quick approaches. And we love getting something for nothing! When the research demands that we take account of the amount of irrational exuberance in the stock price of a given time, the research has to go! The safe withdrawal rate is always 4 percent! Let’s say it all together and maybe we will be able to believe it a little longer!
I’m controversial. Because I said way back in 2002 that the safe withdrawal rate cannot possibly be the same number at all valuation levels. Do that math and you learn that it was 9.0 percent in 1981 and only 1.6 percent in 2000. That’s a big difference.
An investor who retires with a $1 million portfolio can live on $90,000 per year if he retires at a time when the CAPE value is 8 but is limited to only $16,000 in spending each year if he retires at a time when the CAPE value is 44. Hey! The CAPE value that applies on the day you retire is the biggest factor affecting how happy your retirement is going to be, a bigger factor than the dollar-value of your portfolio.
On the one hand, that’s a good reason for paying more attention to stock valuations. If it is stock valuations that are the biggest factor affecting the success of our retirement plans, it would seem that we should be devoting more mental energy to gaining a full grasp of them.
On the other hand, maybe we are not super anxious to obtain a full grasp. There’s a major downside to learning more about how stock investing works in the real world. Stocks are an asset class that encourages self-delusion. We investors can push stock prices to whatever we want them to be. But that darn research can reveal to us that we are living in a fantasy world if we take the official stock prices unadjusted for the amount of irrational exuberance present in them as reflective of reality. Believing in irrational exuberance can be a fun way to live. For a time.
The Great Safe Withdrawal Rate Debate
It amazes me that it’s been 21 years since I initiated The Great Safe Withdrawal Rate Debate and people are still pushing those old studies. Don’t we all want retirement studies that get the numbers right? Apparently not so much.
Here’s the thing. The first word in the term “irrational exuberance” is “irrational.” What Shiller really showed is that investors are highly emotional creatures. When he used research to try to convince them of the error of their ways, he was speaking a language that they do not understand. Research is logic and numbers. Most investors live in an emotional world that cannot be penetrated by logic and numbers.
What would reach them? I don’t know the answer. It’s a question that I think about every day. There are days when I develop what I think might be clues in the solving of the puzzle. But the Buy-and-Holders possess strong radar shields to protect against any incoming flak seeking to force them to reconsider their core assumptions about how stock investing works. So I don’t know.
I comfort myself with the thought that the consideration of valuations is the great lost continent of the investment advice field. It is of course horrible to contemplate that we have known about the error in the Buy-and-Hold retirement studies for 21 years now (if you start the clock running when I advanced my post pointing out that the Buy-and-Hold studies do not adjust for irrational exuberance) or for 42 years (if you start the clock running when Shiller published his Nobel-prize-winning research) and that to this day they remain uncorrected.
But think of how much progress we can quickly achieve once we decide as a nation of people that we are entitled to accurate retirement planning numbers. It’s all there for us when we elect to obtain the benefits of Shiller’s research findings.
Rob’s bio is here.
