Home Value Investing The Safe Withdrawal Rate Scandal Continues

The Safe Withdrawal Rate Scandal Continues

When you purchase through our sponsored links, we may earn a commission. By using this website you agree to our T&Cs.

Valuation-Informed Indexing #129

by Rob Bennett

Michael Kitces is a Maryland financial planner whom I consider a friend. I have had many dealings with Michael in recent years. I comment at his blog frequently. We have engaged in extensive e-mail correspondence. We met in person very briefly at the last Financial Bloggers Conference and plan to get together over dinner at the next one.

You can tell there’s a “but” coming, right?

Michael wrote an article on safe withdrawal rates not too long ago that leaves a bit to be desired in my assessment. The article is titled What Return Rates Are Safe Withdrawal Rates Really Based On?

There’s nothing inaccurate in the article. And it makes several important points. So, if it were written a bit differently, I would applaud it. In the context in which it appeared, however (that is, in a world in which most investors and indeed even most investing experts have shown a woeful lack of appreciation of the dangers of the Old School safe withdrawal rate studies) I view this article as one that does more to add to the problem than to diminish it.

Michael sets things up by explaining that a number of financial planners have been asking whether the withdrawal rate that the Old School studies identified as “100 percent safe” truly are safe. Michael says that they are. He explains that the safe withdrawal rate is determined by making reference to what happens in a worst-case scenario and offers numbers showing that some truly shocking things would have to happen for retirements using a 4 percent withdrawal to fail.

He’s right.

And he’s wrong.

Both things are so!

To see how Michael is right, you need to focus on two words that appear in the sentence immediately below the sub-heading that reads” “Putting Historical Bad Returns Environments in Current Context.” The sentence reads: “Given that safe withdrawal rates are based on historical worst-case scenarios, and given the information we have about how bad those historical scenarios have been, we can begin to understand how bad returns would really have to be, from here, to lead to a safe withdrawal rate that is worse than anything seen in history.”

Can you guess what two words make that sentence, and indeed the entire article, technically correct?

The two magic words are: “From here.”

The Retirement Risk Evaluator shows that the SWR for a retirement beginning today and using a portfolio of 60 percent stocks (this is the allocation examined by Michael) is 3.8 percent. That’s not quite 4 percent. But Michael is entirely correct that it is only if we see one of the the worst returns sequences we have ever seen in history that a retirement beginning today that employs a 4 percent withdrawal rate will fail. A 4 percent withdrawal rate is today a very safe withdrawal rate.

So what’s my objection to the article?

Financial planners should not be concerned only about their clients who are today planning retirements!

The P/E10 value was higher than 23 for most of the time-period from 1996 through late 2008. At the top of the bull, it was 44 and the safe withdrawal rate for a 60-percent-stocks portfolio was 2.7. Millions of middle-class people will be seeing their retirements fail in days to come as a result of the relentless promotion of the demonstrably false claims made in the Old School studies. The government is going to have to step in to deal with the problem and the amount of revenue it will take to deal with it will cause a huge expansion in the Federal budget deficit.

The financial planning industry did this to us. The errors in the Old School studies were discovered in May 2002 (I know because I was the person who discovered them!). There is a universal agreement today that the studies are in error. But even today the studies have not been corrected. Thousands of new retirees fall prey to the errors in these studies every day.

Even professionals are still being taken in. There was a survey of financial planners performed not too long ago that showed that only one in three believe that it is necessary to consider valuations when determining how much a client needs to have in his portfolio to finance a safe retirement. These are people who charge money for their investing “expertise.” For so long as only a minority of the professionals understand the basics, how are the non-professionals ever going to get up to speed?

We have a problem, Houston.

This is the real story here. This is what Michael should be writing about. Many of us are afraid to write about issue that matters most because it is scary to contemplate how much financial misery we have caused with our tolerance of the widespread promotion of Buy-and-Hold strategies (it is the Buy-and-Hold Model — rooted in the long-discredited belief that markets are efficient — that is responsible for studies that fail to take valuations into consideration when identifying safe withdrawal rates).

It’s good news that the crash brought prices down to levels where the claim that a 4 percent withdrawal is safe are no longer wildly off the mark. But to learn from our mistake, we need to acknowledge it openly and plainly and clearly. We need to correct the studies. We need to encourage the publication of new, analytically valid, studies that get the retirement numbers right. We need to get the word out to retirees and aspiring retirees about the mistakes that were made in the Buy-and-Hold days so that we can reduce the damage already done and protect ourselves from seeing even more damage to more retirees in future days.

Michael is right in what he says. But he is talking about one of the less compelling realities of the safe withdrawal rate topic. We need as a society to work up the courage to take on the tougher questions. We will all feel a lot better about our financial futures once we do,

Rob Bennett created The Returns Sequence Reality Checker. His bio is here. 

Our Editorial Standards

At ValueWalk, we’re committed to providing accurate, research-backed information. Our editors go above and beyond to ensure our content is trustworthy and transparent.

Rob Bennett

Want Financial Guidance Sent Straight to You?

  • Pop your email in the box, and you'll receive bi-weekly emails from ValueWalk.
  • We never send spam — only the latest financial news and guides to help you take charge of your financial future.