A while ago I read that Jack Bogle predicts that equities will return only 4% over the next decade. And that already includes dividends and it’s nominal, not real! People call me pessimistic with my equity return assumption for stocks, but good old Jack takes it down another notch. Here’s the quote, reproduced on CNBC:
“Just for mathematical reasons, the dividend yield is 2 percent, a little under 2 percent in fact, and the long-term dividend yield on stocks is pretty close to 4 … the earnings growth on stocks has been a little over 5, that’s going to be a very tough target in the future so let’s call it 4 … 4 and 2 percent give you a 6 percent investment return, but then you have to take … the valuations in the market. …You take that 6 percent return and maybe knock it off a couple of points perhaps for a lower valuation, slightly lower valuation over a decade and you’re talking about a 4 percent nominal return on stocks. And that’s low, lower than history. History is around 6 and a half.”
Wow! That’s a bummer: 4% nominal means about 2% real with a generally agreed upon 2% annual inflation rate. Or another way to look at this return prediction: If we assume that equities pay around 2% in dividend yield, then the equity price index will go up by only the rate of inflation. For ten years!
Everyone in the FIRE community should take notice. If you’re still in the accumulation phase you’ll likely need longer to reach FIRE. If you’re already retired and apply the good old 4% Rule then a Bogle-style scenario will likely put some strain on your portfolio. So, in today’s post let’s look at what the Bogle scenario means for Safe Withdrawal Rates in Early Retirement.
How crazy is Bogle’s prediction?
One little pet peeve I have with Bogle’s analysis: When he says “History is around 6 and a half” he seems to confuse real and nominal returns. Whether you take returns since 1871 (as we do) or 1926 (as they do in the Trinity Study), the average real total equity return has been about 6.7%. So, a 4% nominal return minus 2% expected inflation is a whopping 4.7% p.a. below and not just slightly below historical average.
But Bogle’s assumption is not crazy at all. The current Shiller CAPE is about 30, so according to my personal rule of thumb, this translates into an expected real return of 3.3% (=1/CAPE), but with some substantial uncertainty around it. Taking off another 1.3% safety margin and you’re right at Bogle’s estimate. In fact, if I had to pick among the two widely cited “crazy predictions,” 4% from Bogle and the 12% estimate from Dave Ramsey, I’d try my luck with the Vanguard guy!
What do we do now?
Are we all screwed now? Should we delay our Early Retirement? Run for the hills, sell stocks and go into bonds? Hold your horses! Just like Oracles from Ancient Greece, this Oracle of Valley Forge (Vanguard Headquarters) made a prediction with a lot of ambiguities. Even if we take the 4% prediction at face value, notice the two extremely important pieces of information Bogle didn’t elaborate on:
- What are his return expectations for year 11 and onward?
- 4% annual returns implies a cumulative compound return of about 48% in year 10. But what’s the path for equities in between? As we have learned from our research on Sequence of Return Risk (see part 1 and part 2), in retirement, the average return is much less important than the order/sequence of returns.
So, let’s look at the two issues:
1: What comes after year 10?
Notice what Bogle didn’t say: He didn’t say that the 4% return will persist beyond year 10. The way I interpret Bogle’s quote is that the next 10 years are merely an adjustment process. We have slightly lofty equity valuations and that underwhelming equity return will bring equity valuations back to normal. This view would be supported by that other oracle, the one from Omaha who had this to say last year:
“For 240 years it’s been a terrible mistake to bet against America, and now is no time to start. America’s golden goose of commerce and innovation will continue to lay more and larger eggs.” Warren Buffett in 2016 letter to Berkshire Hathaway shareholders.
So, my interpretation of Bogle’s quote is that the 4% return assumption is only temporary, not permanent. Let’s assume that the Price index grows by only 2% (4% minus dividend yield) and profits keep growing at just 4%, i.e., about in line with nominal GDP. Historically, nominal GDP grew faster than that and profits grew even a little bit faster than nominal GDP, but let’s be conservative here. As the profits starting point, we use the $105.52 EPS figure from S&P for the second quarter of 2017 (estimate as of 6/6/2017). I also use a 2429.33 S&P level from yesterday’s (June 6, 2017) close.
Equity valuations will look quite attractive again after 10 years, see the table below. The PE ratio goes down to under 19 and the Shiller CAPE ends up in the low 20s, much closer to the historical average. With valuations like that, we can again expect much more generous returns going forward! If equities return to anywhere close their historical average returns (6.7% real) in year 11, then the 10 years of lean returns may not be too damaging to our FIRE strategy!
2: Sequence of Return Risk
To deal with the Sequence of Return Risk issue, let’s look at 3 scenarios: the Boring Bogle, the Bad Bogle, and the Good Bogle. Try to say this three times in a row as fast as you can!
- Boring Bogle: Equity returns are exactly 4% nominal every year for 10 years.
- Bad Bogle: Equity returns are -30% over the next year, then flat in year 2 and then +9.8% for 8 more years. This averages out to exactly 4% compound return over the 10 years.
- Good Bogle: Equity returns are 9.8% for 8 years, then flat in year 9 and -30% in year 10. Again, the average return is exactly 4% p.a.
Hold on, didn’t we forget something? How about bond returns? With the assumptions above we can only simulate a 100% equity portfolio, which is not too far away from our personal portfolio but may not be acceptable for many others in the FIRE community. Well, Jack Bogle didn’t mention anything about his return assumptions for bonds, so I can “make up” my own numbers, right?
Here are the assumptions on the 10-year bond yields. In all three scenarios, we start with an initial yield of 2.2%, the value as of early June. Since then the yield dropped to 2.15% on June 6, but the difference is small enough to not materially impact our simulations,
- Boring Bogle: From the initial yield of around 2.2%, let’s assume that the 10Y yield climbs to 3.2% in a very gradual fashion: 0.10% per year.
- Bad Bogle: The yield will also end up at 3.2% after 10 years but it has to take a very different path: In response to the equity crash and likely recession early on, the Federal Reserve again slashes interest rates and probably starts some other monetary easing programs (QE4, QE5, etc.) and causes a drop in yields initially, but then we observe a rapid rise back to 3.2% by the end of year 10.
- Good Bogle: Interest rates rise much faster in response to the strong economic expansion. The 10-year yield reaches 4.3% in 2025 after a record-long expansion of 16 years. Then we experience a drop in yields back to the 3.2% after the Fed uses monetary easing.
The bond returns assume that you hold an ETF of 10-year Treasury bonds that constantly rolls out bonds when their maturity falls too far below the target maturity and rolls in new bonds as their maturity reaches 10 years. Notice how this is different from holding one 10-year bond today until maturity (which is not what most bond ETFs are doing). See the assumptions below:
Due to the high duration (interest rate sensitivity of the 10-year bond), we get this nice diversification benefit of the bond portfolio: Very high returns in years 1-2 during the Bad Bogle scenario and years 9-10 in the Good Bogle scenario. Exactly when the equity portfolio is down! Also notice that in the Boring Bogle scenario when bond yields move up slowly, the realized bond returns are lower than the yield. That’s because you constantly lose to the duration effect, -0.80%, which is due to the 0.10% increase in yield multiplied by a duration of 8.0. (current estimate of the iShares 7-10 year Treasury Bond ETF, ticker IEF duration is 7.51).
Simulations
- 10-year horizon, at an annual frequency.
- Withdrawals occur at the beginning of the year.
- Stock/Bond allocation between 50/50 and 100/0. We also throw in two equity glide path scenarios starting at 60% and 80% equities in year 1 and then shifting to 100% equities in 5% increments.
- We look at three initial withdrawal rates: 3.0%, 3.5% and 4.0%.
The results are in the table below. We display two crucial final outputs:
- The final real portfolio value after 10 years, as a percentage change relative to the starting portfolio.
- The year 11 effective withdrawal rate if we wanted to keep withdrawing the initial amount adjusted for inflation.
Summary of results:
- There is no hiding from the Bogle scenario. The portfolio value after 10 years will be down, and it’s mostly a matter of by how much.
- Bonds are an even worse investment than stocks. The final portfolio value is decreasing in the bond share. If you view Bogle’s warning as a call to reduce the equity share in your retirement portfolio, you couldn’t be more wrong!
- A glidepath with an initial bond allocation and then shifting into 100% stocks over time could serve as a hedge against the Bad Bogle scenario. Of course, if we’re in the “Good Bogle” scenario you still are better off with 100% stocks, so the glidepath scenario merely serves as a hedge against a worst-case scenario.
- The glidepath with 80% starting point seems to have the most consistent and robust final outcome. All year-11 withdrawal rates fall into the low 4% range when the initial SWR was 3.5%. Starting with 60% bonds might be too much bond exposure because if you’re “unlucky” and the equity bull market continues for 8 years only to end in a crash in years 9-10, then the glide path from 60-100% would imply a 4.68% withdrawal rate in year 11. That may be a little too high for comfort even if the CAPE is back to just above 20.
- A 3.0% SWR looks too conservative! The 80/20 to 100/0 glidepath ends up with an effective withdrawal rate of 3.32-3.46% in year 11. If we believe that equity and bond valuations have returned to a more normal level by then we should easily support a withdrawal rate in the low 4% range. Especially considering that we have already run down the retirement clock by 10 years.
- The 4% initial SWR seems way too aggressive. The static portfolio allocations all end up with a 6%+ effective WR in year 11 under the Bad Bogle scenario and also significantly above 5% in Boring Bogle scenario. In year 11 you’d have two choices: Either continue with the withdrawal path and risk running out of money or significantly reduce the withdrawals at that time. Not a pretty picture!
Summary
The more I look at the research on Safe Withdrawal Rates the more I like the 3.5% Rule. It’s high enough to not significantly delay anyone’s FIRE plans. If you have been planning on a 25x annual spending (4% rule) you are now looking at a target of “only” 28.6x spending. Come on, that’s not so hard! And it’s low enough to weather even this unpleasant Bogle scenario.
The other lesson from this exercise: Becoming too risk-averse and lowering the SWR to 3.0% or even below may actually be too conservative! How about that? As someone who is a perennial skeptic, I finally have some good news for the FIRE community. Chill out, everybody, you don’t have to go that low. A 3.5% SWR is all you need!
Thanks for stopping by today! Please leave your comments and suggestions below! Also, make sure you check out the other parts of the series, see here for a guide to the different parts so far!
Picture credit: pixabay.com
What a relief ERN! Just when I feared you will go below even my ultra conservative 3.27%, you deliver the reassuring 3.5%. Yes, Big ERN! Thanks for making me feel good 👍
Haha, thanks TFR! Looks like 3.25 to 3.5 is the sweet spot!
Whether it’s Good, Bad, or Boring Bogle, or some other Bogleation not simulated, I don’t think anyone will be terribly surprised to see subpar returns over the course of the next decade. It is comforting to see that a 3.5% withdrawal rate will weather any of these storms, though.
As you probably know, I’m contemplating one more year or two more years of part time work. On one hand, with the schedule I’ll have, it seems like easy money and a no-brainer to work that second year. But, I’m already good to go with a sub-3.5% withdrawal rate and I have some additional online income that will act as an additional buffer. Which makes me think I could very easily join you in retirement next summer. Time will tell.
Cheers!
-PoF
Hi PoF! Thanks for stopping by. Yes, that’s a great approach to preserve the capital for 2 more years. If I could do 1/2 time I would do the same! Cheers!
Wonderful post.
>The current Shiller CAPE is about 30, so according to my personal rule of thumb, this translates into…
I think the job of properly interpreting the current Schiller CAPE is made very difficult by the fact that there have been large changes in accounting rules for reported earnings since 1993 (see Jeremy Siegel’s paper: http://www.cfapubs.org/doi/pdf/10.2469/faj.v72.n3.1 ). It seems that we should compensate for these accounting rule changes by being less intimidated by high post-1993 CAPE values. For example, this wrinkle leads Jeremy Siegel to increase his forecasted Jan2015-Jan2025 annualized total return by 3 percentage points to 5.25%.
What do you think about treating current CAPE values much differently than pre-1993 CAPE values? Is no adjustment too pessimistic? Is Jeremy Siegel’s adjustment too optimistic?
Jacob,
Take a look at the comments section of ERN’s Cape Fear entry from a couple of months ago https://earlyretirementnow.com/2017/03/22/cape-fear/ where Big ERN responds to some of my ramblings on issues with the “E” in CAPE.
Yes, and your links remind me to mention that there’s much more changing about companies and the investing landscape than accounting practices. There’s lower interest rates, less risk to investors, less debt in companies, and perhaps most importantly: a seeming increase in earnings growth.
Anyway, at that post, ERN comments “I can also see that changes in accounting standards make the CAPE less comparable across time. But they won’t explain a CAPE of 29 today vs. a 16 average before…whatever the way out of today’s CAPE of 29 may be, the implications for withdrawal rates are the same: withdraw less…option 2: If we entered a low-growth, low risk-premium, low-interest new-normal then we still withdraw only 3%. in line with lower growth expectations”.
Seems like ERN’s taken a position: CAPE-like numbers are still high enough to forecast returns below the historical average. I’d like to raise the possibility of option3: option2 without the lower growth. Maybe historically-average returns can’t happen without historically-average risk, but I’m open to the possibility. I’m also open to the horrible optionJ: 1989-2016 Japan happens to us. My best guess is slightly below average returns over the next 10 years, but note that I have very very low certainty on this prediction.
ERN has done great work and has influenced me to be more conservative with my SWR than I would have otherwise. Right now planning on ~3%.
Well, let’s hope it’s not that option J, as in Japan! Japan in the late 80s had some pretty crazy PE ratios, much higher than in the U.S. today. So I’m hopeful we will not get the Japanese style lost decade(s).
Ha, good point! Thanks for pointing to that discussion!
Great point! I wholeheartedly support the idea of a shift to today’s CAPE ratios supporting higher SWR. I wouldn’t bet on a hole 2.25% higher expected return, though. But I’d think that a CAPE of 20 is the new normal. Cheers!
Big ERN,
Wednesday mornings always make me giddy with the anticipation of perusing your latest posting of tasty insights. Another fantastic entry today IMHO!
A slightly different view of the same issue is to look at the real return of the S&P 500 over several decades. It is not at all what most folks believe it to be. Record highs are clustered together in time when viewed long-term. Here’s a graph that shows the “real-ity”: https://828cloud.files.wordpress.com/2017/01/c170116a.jpg?w=1260 .
Can’t wait until your next blog post!
Thanks! I have seen that chart too, but it looks like that’s the real S&P 500 without dividends reinvested. Early on dividend yields were much higher than today’s paltry 2%. The cumulative real index with dividends invested is here (up to early 2016):
https://earlyretirementnowdotcom.files.wordpress.com/2016/05/bondsriskierthanstocks_022.png?w=768
(From the post “when bonds are riskier than stocks: https://earlyretirementnow.com/2016/05/19/bond-vs-stock-risk/ )
I’m a big Bogle guy. And a big PE10 (shiller cape ratio) guy. So I agree with you that returns going forward don’t look that great, from a strict valuation standpoint. But only here in the US. International (especially emerging markets) still look good. I’ve gotten a 35%+ return on my emerging market allocation ($200K), in the past year and half. And I see it continuing to do well. I like Europe too.
Good for you! And it is about time for EM stocks to recover. I think the EEM ETF is still slightly below the pre-2008 high. I’m still on the fence about shifting more money into international stocks. They also have more volatility. In the Bad Bogle scenario if the U.S. index drops by 30%I wouldn’t be surprised if alot of the high-beta international stock indexes go down by 40+%.
But still, best of luck with your EM stocks!
Cheers!
I’m with Tim here. All the business fundamentals and analysis on projected returns in the US has convinced me to move more of my portfolio to international stocks, particularly EM. I made a really big shift in allocations early last year after the terrible EM returns the previous 5 years. The timing was luck but I’ve enjoyed some really nice gains and there is still a lot of room to go before international investments are anywhere close to the cost of US stocks. I still recommend a 3% SWR for early retirees but I think a larger international allocation will help over the next 5-10 years.
And if EM stocks are dragged down by a big drop in US stocks (very likely), then I’ll be buying/shifting even more because the recovery will be awesome!
This is slightly off-topic but I recently looked up annualized returns for SPY and EEM from 2001-2018. EEM outperformed 10.8% to 6.4% with a p-value (two-tailed T) ~ 0.4. R = 0.7251 (p < 0.001).
Do you think this means anything with regard to diversification even in the face of the currently elevated CAPE?
“Everyone in the FIRE community should take notice. If you’re still in the accumulation phase you’ll likely need longer to reach FIRE.”
As an accumulator, I have to root for the Bad Boggle scenario. 4% nominal returns for a decade aren’t good for anybody, but I’d much rather get my future contributions in at a significantly lower valuation. In a theoretical universe where the market *did* correct by 30% in the next year or so and then resume normal growth, early-stage accumulators might not have to adjust their FIRE plans at all!
Ha, good point! This goes back to our Parts 14-15 of the series: The retiree’s loss is the accumulator’s gain. You would certainly profit from a temporary dip! Best of luck!
Hey, thanks for another great post! I’m sure you’re already aware, but Dr. Bernstein’s 10-year prediction is right in line with Bogle’s, and I respect him quite a bit as well. I’m sure you’ve run this, or thought about it, but I’d be curious to see how overlaying some of your variable withdrawal work in the earlier posts, or prime harvesting onto the different Bogle Scenarios improves the portfolio value at year 10, and at what withdrawal cost. I’ve got to believe that just a little bit of flexibility (or dare I say, Mustachianism) ought to leave one in even better shape, perhaps preserving up to 90% of the original inflation-adjusted portfolio value, with just a little tweak to the withdrawal rate in bad years.
For example, my plan is to retire early in 3-4 years, with around a 3% SWR and some flexibility built into my budget. Good Bogle – no problem, I’ll go on a bicycle tour across the country that has support vehicles to shuttle your gear and includes stays in B&B’s. Bad Bogle – I’ll stay in campgrounds and carry my gear in panniers. Either trip will be awesome! The point of early retirement is having time to do stuff you’ve always wanted to do, while you still have energy and health to enjoy it!
Good question. The CAPE based rule 0.5/CAPE+1.5% would start at 3.2% initial WR and then scale up slowly to 3.8%. Not too different from the 3.5% rule.
Guyton-Klinger would have triggered the lower guardrail in the Bad Bogle scenario. I haven’t run the precise simulations though. I will check once I’m back from vacation this coming weekend
Cheers!
Love it!! I’m cycling and backpack my way through early retirement as well!
This is a great analysis, ERN, especially for those in the FIRE community looking to retire in the near-term (like yourself). The speculation of retiring at a peak may be scary, but sound analysis like this is reassuring. I may ask for a re-assessment of this article when I’m ready to retire in a few more years 🙂
Haha, I will do a special customized case study just for you in a few years when you are ready to reite! Thanks for stopping by!
Hmmmm… Again, quoting Jack Bogle’s formula and if you have read his books:
http://awealthofcommonsense.com/2016/09/the-john-bogle-expected-return-formula/
He does indeed look at returns in 10-year cycles, not forever.
Funny enough, it does seem he confused long-term nominal and real returns in that interview.
However, his numbers as per the above link and books seem to work out quite well. Something which he mentions extensively in them is that what is indeed not possible to predict ex-ante is the change in the P/E ratio, which greatly affects his equation.
From the changes in the P/E ratio over the past century from the the table in the above link, one can see the maximum change is 9.3%, and that includes the Great Depression and the Dotcom bubble. So your 10-year -17.63% change in the P/E ratio looks grossly off and suggests one of your assumptions is wrong.
Bogle’s 2% dividend yield + 4% earnings growth +/- P/E ratio change over the next decade, which presumably will be negative, as you rightly point out, CAPE being in the 30’s, does point out to the 3.3% (or lower) return implied by the inverse of CAPE. (earnings yield).
My numbers are not grossly off. The -17.63% is cumulative over 10 years. The numbers you reference are annualized over 10Y periods. The -17.63% over 10 years works out as pretty much exactly -2% annualized. And viola you get exactly Bogle’s formula:
Annualized return = Div Yield + Earnings GRowth + Change in PE ratio:
+4% = +2% + 4% -2%
Doh, you’re right!
Rookie mistake for skimming too fast through the article. Thanks for pointing it out!
Still yields 4% nominal returns, close to inverse of CAPE, though (for the coming decade). I must admit I’m still with Bogle on this one… (except for the confusing historical nominal and real returns, but I’d like to see how any of us will discuss this when we’re his age, if we even can!)
Ha, no problem! Happen to me all the time!
I don’t understand the comment by the Quiet Investor and hope that you two will continue that dialogue to clarify its meaning and significance. That aside, this post by you, Big ERN (well-merited moniker), followed by comments of other savvy quants, give this lawyer comfort that he can retire at age 61 (with a 59-year-old wife) on an AA even of 50/50 and a SWR as high as 3.5 percent.
So pushing the AA to 60/40 or higher is even safer (if we can stomach the volatility). And decreasing the WR to 3.25 or even 3.00 likewise is safer (if needlessly frugal).
Especially in that there is no legacy need, other than charities who can hope for better-than-worst-case returns.
Working longer for an economic return on a part-time or “encore career” basis obviously provides additional security, as noted. But it’s not essential.
If I misunderstand anything, please do advise. I believe Big ERN has, in this latest post particularly, performed an extremely valuable service for all near-term retirees.
The other commenter calculated a 10Y cumulative drop in the PE ratio, but then compared it to an annualized PE change. Not a good idea! 🙂
Yes, pushing the equity allocation higher is the way to deal with this low return problem. Sounds counter-intuitive, but this is the way I look at it: If equities return 6% real, 8% nominal then you can afford to shift more into bonds to reduce volatility. If equity expected returns are lower (and bond returns are low as well) then you need the earnings power of equities to make the portfolio last.
Cheers!
Thanks for the great analysis. I’ve been thinking about the low yield after I read Bogel’s comment. The valuation is just too high so it makes sense that the stock market won’t return as much over the next 10 years. Cutting back on withdrawal rate is a good plan, but I’d prefer to increase the return a bit too. I shifted some investment to international. We’ll see how that works out over the next decade..
Good luck!
Thanks for sharing, RB40! I am directing new equity investments into All-World ex-US, too. Small amounts only! I haven’t had the nerve yet to shift any sizable amounts into international. My concern is that the rest of the world is cheap for a reason: low growth in Europe and Japan and high risk in EM. I wouldn’t want to completely miss out on international stocks, of course. Agree: let’s see how it works out over the next 10Y.
Cheers!
Great add to the series, thanks again for the efforts.
One thought though, and feel free to point out if I’m thinking about this incorrectly in some way — withdrawal rates aren’t constant for many (most?) folks, right? For a subset of us, sadly myself included, the end of the 10 year period used also approximately coincides with when we start dipping into tax deferred accounts and incurring the additional tax burden, and before some level of offsetting SS inflows arrive (yet another change in WR). Adds additional withdrawal requirements around the same period higher WR’s due to market conditions (presumed, but I’m certainly not betting against Mr Bogle, at least directionally) are a reality. That may be a good argument for a more conservative starting initial withdrawal rate, for folks in a similar scenario?
The tax issue is a serious one. Some people can pull off the withdrawals all tax-free with Roth conversion ladders. We will likely face a 15% initial marginal tax rate and even 25% marginal tax rate once 401k distributions start. We will definitely budget conservatively due to this issue. Thanks for bringing that up!
I am enjoying your entire series on safe withdrawal rates. One question I have, though, is what do you think about Jim Otar’s view of a 2.3% perpetual withdrawal rate (http://retirementoptimizer.com/Whitepapers/PerpDist.pdf)? In my most conservative, worst-case-scenario planning I default to a rate closer to 2.3%, and by comparison your suggestion of 3.5% (and even your “100% safe” 3.0%) seem overly optimistic. One obvious difference is the time frame parameter of 60 years vs “perpetual,” but that alone should not make for such a wide discrepancy. What else might account for such a difference in calculations?
Interesting link. I like the idea of using historical returns (just as I do), as opposed to the can-of-worms of Monte Carlo. We actually get similar results. If I use a 40Y horizon, 70/30 Stocks/Bonds and a final target value of 100% times initial adjusted for inflation I get a fail-safe PWR of 2.65%, i.e., the lowest sustainable SWR that reaches this target.
I don’t get why he uses only 40% equities. He makes some pretty wild and nonsensical claims: “importance of asset allocation diminishes significantly” that are certifiably false. You have to shift your S/B allocation depending on the horizon, and ideally even use a glidepath during retirement to hack the portfolio allocation. Maybe he writes that because he doesn’t have much finance training.
I may not be correct, but here is my understanding of the calculation differences: Otar’s goal is to never dip below the inflation-adjusted starting value throughout the 40 years of calculations. Your goal is to end the 40 years at least as high as the inflation-adjusted starting value, even if it dips below that value in the interim. Would you agree with this assessment? If this is correct, then I guess that would also explain his use of 40% equities (less volatility) vs your recommendation of 70%.
Regarding his “nonsensical claim,” I think he just means to say that as withdrawal rates approach the PWR of 2.3%, SRR becomes much more important than asset allocation. Is this not a statement that you would agree with?
So here are a few more questions for you:
1) Based on your chart in part 3, looking at a 3.5% SWR with the current cape and a FV of 50%, the probability of success is about 83%. Given that, is it realistic to recommend a 3.5% SWR as you have done in this post?
2) Just for curiosity’s sake, is there a way you would easily be able to tell me what the fail-safe PWRs are for 70% stocks with 30Y and 60Y horizons with the current CAPE of about 30?
3) Speaking of the CAPE graphs, excuse me if I missed this but why is there a higher probability of success with a higher CAPE, with all else being equal? For example, looking at the 3.5% SWR, 60Y horizon graph, at 70% stocks there is a higher probability of success with a cape of 35 vs 25. I’m sure I’m missing something, but this seems very counter-intuitive. If stocks are more overvalued, then the SRR is higher so there should be a lower probability of success, right?
Thanks for your responses!
About your questions:
1: Without any additional income I would recommend 3.25%. With a modest Social Security income, I would go as high as 3.5%. I would also recommend 80/20 rather than 70/30.
2: Conditional on the CAPE at 30 or below the Fail-Safe is at 3.18%. 70/30 portfolio, 60Y horizon.
3: For 100% equities the sorting is “correct”: the higher the CAPE the lower the success rate. For 70/30 you run into the situation where the 1997-2001 episode doesn’t look so bad. There were some months where the CAPE was high but kept rising and with 30% bonds you would have skimmed the bubble gains into bonds and that protected you come 2001. So the sorting can be counter-intuitive when you have significant bond shares.
Thx for doing all this work for us. 3,5 sounds like a good number when You would FIRE today.
I will evaluate CAPE when close to retirement to see what I need to take. Go with the classic 4 or take the safer 3,5.
with the current insights I have now and the Belgian system being what it is, I will probably go with an hybrid FIRE approach where work is always part of life. Just less work each year.
Well, if your FIRE date is further down the road then a 25x/4% might work (again). Time will tell.
Thanks for stopping by!
Thank you for your helpful responses; I’m already using some of your figures in my retirement spreadsheets. This is a great series so please keep up the good work.
By the way, I found one small web issue that I hope you find helpful. The Navigation at the bottom of each post (after the post, before the comments) doesn’t always show the other all the parts. For example, the bottom of part 1 correctly shows parts parts 1-16. The bottom of part 2 only shows parts 1-13. The bottom of part 13 shows 1-14. I found this when I was on part 3 and had trouble navigating to part 16, which I knew existed but could not find. Not a huge deal, but I hope this helps to improve an already-great site!
Ha, good point! I have to manually go back and add each new post to all of the previous 15 posts. Must have forgotten. 🙂 I add those one of these days. Until then use this:
https://earlyretirementnow.com/category/safe-withdrawal-rates/
or use Part 1 that has all the links!
Cheers!
Including the date of publication at the top/outset of each of your posts would be super helpful and appreciated too!
For some reason, the new WordPress theme doesn’t display this anymore at the header. Let me check if I can add this again…
Been following this series with enthusiasm. A couple thoughts/questions I would like to get your take on… First, doesn’t it seem like the SWR can in fact be taken off of the highest historical portfolio value (assuming no adjustments in allocarion or withdrawals) if SWR is properly calculated? Secondarily, I have generated separate SWR for separate categories of spending…i.e. my travel account assumes a higher and more flexible SWR than that designated for medical costs…I am aware from reading your “tome” (seriously lol) that you are not a big fan of flexible SWR but for my situation it makes sense for a few reasons that are beyond the scope of a comment. Interested in your thoughts on both. Thanks a lot and keep it coming!
Good points:
The problem with the fail-safe SWR (one that has worked even under the most adverse circumstances: a) it’s really low (significantly below 3%) and b) you don’t know if the previous low was really the lowest we’ll ever observe.
I like the SWR for different categories. But don’t overdo it! If you get too much into this bucket thinking you could fall for the “mental accounting” behavioral bias:
Been following this series with enthusiasm. A couple thoughts/questions I would like to get your take on… First, doesn’t it seem like the SWR can in fact be taken off of the highest historical portfolio value (assuming no adjustments in allocarion or withdrawals) if SWR is properly calculated? Secondarily, I have generated separate SWR for separate categories of spending…i.e. my travel account assumes a higher and more flexible SWR than that designated for medical costs…I am aware from reading your “tome” (seriously lol) that you are not a big fan of flexible SWR but for my situation it makes sense for a few reasons that are beyond the scope of a comment. Interested in your thoughts on both. Thanks a lot and keep it coming! Sorry bout the double post forgot to check the notifocation box…
No problem! Very thoughtful comment!!!
Hi, I have a question about this study. Does this study of 3.5% to 4% hold true for other markets than USA also ? Would it hold true for INDIA with inflation at 7% and approx equity returns around 12% ( current 6-10 years average return in a good mutual fund )
You’d have to rely on the assumption that India generates similar real returns as the U.S.
I’m not familiar with the bond market over there but one could argue that Indian stocks are quite attractively valued (measured by CAPE ratio), so my quick answer would be that yes, you can probably use a similar SWR (or maybe a bit higher) in India.
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You actually make it appear so easy together with your presentation however I to find this matter to be actually one thing which I think I’d never understand. It kind of feels too complex and extremely extensive for me. I am looking ahead on your next put up, I’ll try to get the grasp of it!