Can we raise our Safe Withdrawal Rate when inflation is low? – SWR Series Part 41

October 26, 2020 – A few weeks ago I wrote the post “Do we really have to lower our Safe Withdrawal Rate to 0.5% now?” about the pretty ridiculous claim that the Safe Withdrawal Rate should go all the way down to just 0.5%, in light of today’s ultra-low interest rates. The claim was transparently false and it was great fun to debunk it. But recently I came across another proclamation of the type “We have to rethink the Safe Withdrawal Rate” – this time proposing to raise it all the way up to 5% and even 5.5%! Well, count me a skeptic on this one, too. Though I’d have to tread a bit more cautiously here because the 5.5% SWR claim doesn’t come from some random internet troll but from the “Father of the 4% Rule” himself, Bill Bengen. He’s been doing the rounds recently advocating for a 5% and even 5.5% Safe Withdrawal Rate:

  • In September in a piece he wrote for FA-mag with a recommendation to raise the SWR to 5%.
  • On October 1, the same article, reprinted almost verbatim under a different title in the same magazine: “Choosing The Highest Safe Withdrawal Rate At Retirement”
  • On October 13 on Michael Kitces’ podcast, Bengen made another explicit SWR recommendation: “[I]n a very low inflation environment like we have now, if we had modest stocks, I wouldn’t be recommending 4.5%, I’d probably be recommending 5.25%, 5.5%” It’s not clear what made him raise the SWR by another 0.25-0.50%, though.

And the whole discussion was quickly picked up in the personal finance  and FIRE community:

The main rationale for increasing the SWR: inflation has been really tame recently and will stay subdued over the coming years and even decades. That’s his forecast, not mine! Hence, Bengen makes the case that we’d have to make smaller “cost-of-living adjustments” (COLA) to our withdrawals. Smaller future aggregate withdrawals afford you larger initial withdrawals, according to Bengen. But as you might have guessed, the calculations that justify the significantly higher withdrawal rate don’t appear so convincing once look at the details…

How does Bill Bengen justify the new 5+% number?

First, let’s take a look again at how Bill Bengen justifies the upward revision. Very simple. The bump from 4% to 5+% comes from two major adjustments proposed by Bengen:

  • First, we can increase the SWR from the baseline level of 4% to about 4.5% if we get a bit more adventurous with our asset allocation. An overweight to small-cap stocks would have indeed increased your failsafe withdrawal rate to about 4.5% in historical simulations.
  • Second, inflation is low right now. Lower inflation implies lower COLA in your withdrawals. And since the cumulative future nominal withdrawals are smaller we can bump up that initial withdrawal.

So far, so good. The only problem: both adjustments are standing on very, very shaky foundations. Let’s look at some of the problems in that logic…

Problem 1: Small-cap hindsight bias

If you’re an avid ERN blog reader you may know that I’ve written about the Small-Cap style (as well as value style and small-cap-value style as well) before, most prominently in 2019: “My thoughts on Small-Cap and Value Stocks”. Yeah, sure, small-cap stocks would have indeed outperformed large-cap stocks and also the total market index for many decades, see the chart below:

Fama-French SMB factor 1926-2020. Small-cap was unable to continue its winning trend after 1980!

But incidentally and ironically, ever since the small-cap outperformance bias was pointed out in the academic literature, about 40 years ago, small-cap stocks would have had only underwhelming success. And most recently, small-cap stocks would have vastly underperformed during the last few years, including the 2020 recession & bear market. So, pretending that the small-cap outperformance of the past will last indefinitely, almost like some fundamental law of physics, seems like bad advice to me. 

Problem 2: Which small-cap index?

There isn’t one single generally accepted small-cap index. Bengen displays data for a portfolio with 30% large-cap stocks, 20% small-cap stocks, and 50% intermediate Treasury bonds. In my own simulations, I rely on the Fama-French SMB factor (SMB) to simulate small-cap stocks. The way to implement this in my Google Sheet (see Part 28 for details) is to set the stock market share to 50%, the bond share to 50%, and then add a 20% style shift to small-cap stocks, see below. (the idea here is that 30% is for large-cap and then 20% large-cap plus the SMB factor tilt gives you 20% small-cap, i.e. Big+Small-Big=Small!). Also notice that for this exercise we have to set all of the supplemental cash flows (see tab “Cash Flow Assist”) to zero!

Implementing the Bengen 30/20/50 portfolio in the Big ERN Google Sheet!

In the chart below, I plot the monthly safe withdrawal rates between 1925 and 1990 for the Bengen portfolio but also for a standard 60/40 and 50/50 portfolio (i.e., with only large-cap/S&P 500 index, no small-cap tilt). Notice that the 30/20/50 portfolio has asset returns only since July 1926. It appears that small-cap stocks indeed help you with the SWR on some occasions, very prominently in 1929. But small-cap stocks don’t seem like a panacea either. In 1968, your failsafe withdrawal rate dropped to 3.88%. So the claim that small-cap stocks necessarily raise your SWR all the time seems very doubtful, even for some of the cohorts that retired well before 1980!

Safe Withdrawal Rates for different asset allocations. 1925-1990. Using Return data until 2020.

What exactly explains the discrepancy between my failsafe calculations and Bengen’s SAFEMAX is not clear. Bengen didn’t elaborate on what exact index returns he employed. It’s possible that the S&P500+SMB gives you different results from other Small-Cap indexes, even though I found that the IVV (S&P 500) plus the Fama-French SMB in equal shares will very closely resemble the iShares IWM (Russell 2000 Small-Cap Index) using actual return data since 2000. IVV+SMB even outperformed the IWM ETF a bit between 2000 and 2020. At the very least, the small-cap boost to SWRs is not all that consistent if the alpha depends so much on which exact small-cap flavor you use.

It’s also possible that because my analysis is more granular (monthly frequency of both the start dates and withdrawals), I’d pick up some of the lower monthly SWRs that Bengen (quarterly frequency) or other researchers (often annual frequency) might miss. 

But just to make sure, for today’s post, I don’t like to delve much more into the small-cap issue. I like to focus more on the laundry list of problems pertaining to Bengen’s second claim, that low inflation predicts high SWRs. Thus, in the remainder of the post, I’ll just simply work with the historical data, with the significant and persistent small-cap alpha built-in, and show that the case for higher SWRs due to lower inflation rates still doesn’t hold water, despite including small-cap stocks. So, let’s move on to the next problem I found…

Problem 3: One-year trailing inflation is not a very good predictor for inflation over the next 30 years!

The rationale for “low inflation => high safe withdrawal rate” doesn’t work quite as well as Bengen wants us to believe, more on that below. But for the sake of the argument, let’s assume that his logic is indeed sound and a lower inflation rate allows you to raise your safe withdrawal rate. Do you notice a hole in his story, though? I do! We don’t know the inflation rate over the next 30 years. All we have right now, and all Bengen uses in his analysis is the final 12-month window before retirement to form the different buckets in Figures 5 through 10. But since it’s the future 30-year inflation rate that matters for my retirement cost-of-living adjustments, the following important question comes to my mind:

How much predictive power does the trailing 12-month inflation number have for the 30-year future inflation rate?

Unfortunately, not much. Let’s look at a Scatter Plot with the 12-month trailing CPI rate on the x-axis and the subsequent 30-year future realized annualized inflation rate on the y-axis. See the chart below. I call this a pretty spurious relationship with a positive but very low correlation. I display this for two different starting points 1872 (full sample, top chart) and 1926 (partial sample, used by Bengen due to the small-cap data availability, bottom chart). Notice the final observation is 1990 because that’s where the final 30-year realized inflation window starts.

Scatterplots: 1-year trailing CPI vs. 30-year subsequent (annualized) CPI. All numbers in percent (%).

The R-squared measures are minuscule, between 0.02 and 0.04. In statistics, we sarcastically call them the “Irish R-squareds” (O’One, O’Two, O’Three, O’Four, etc.) and they are the stats lingo for “ya got nothing there, buddy!”

I should also point out that even though the correlation and slope go in the “right” direction, the positive sign of the slope is not statistically significant. If you calculate the Newey-West, heteroscedasticity-adjusted t-stats (due to overlapping windows we can’t use the naïve OLS t-stats!) I get 1.32 for the full sample and 0.85 for the 1926-1990 sample. Doesn’t make the threshold for a significantly positive slope.

And even if the t-stats were statistically significant, the slope estimates are only 0.0507 for the full sample and 0.0375 for the shorter sample in the Bengen sample, respectively. Forget about the weak statistical significance, I call those beta estimates “not economically significant” because that means that if our current 12-month trailing CPI rate (1.4%) is about 0.6 percentage points lower than the multi-decade average, then our estimate for 30-year forward inflation rates should move down by only about 0.02% to 0.03%. Even if you assume that a lower long-term inflation rate increases your expected real return one-for-one (it might not, more on that below), why would a 0.03% higher real return increase your safe withdrawal rate by between 0.50 to 1.00 percentage points? The numbers don’t add up!

Problem 4: Bengen seems to inadvertently agree with my “Problem 3” above!

I was intrigued by the 6 tables (Figures 5 through 10) where Bengen proposes withdrawal rates in different buckets. First, he creates six tables for the six different inflation regimes, and then within each table, he buckets again by the CAPE regime. Consistent with Michael Kitces’ research, different initial CAPE readings had a huge impact on your SAFEMAX, so in each table, the SAFEMAX declines as the CAPE rises.

Bengen SWR Table01
Bengen Tables proposing SAFEMAX values for different CPI/CAPE regimes. Source: FA-mag.–safe–withdrawal-rate-at-retirement-57731.html?section=131

So far, so good. But if you read along the other direction, different CPI-regimes for a fixed CAPE value, there doesn’t seem to be too much variation in the SAFEMAX values.

For example, let’s compare the two CPI bucket 0%-2.5% and 2.5%-5.0% (two very important buckets as we shall see below). Here are Bengen’s proposed SAFEMAX values for CAPE values of 14, 16, 18, and 20, see the chart below. You will notice that the difference in SAFEMAX values for the two CPI regimes 0-2.5% vs. 2.5-5.0% is minuscule. And for the CAPE=14 and 16 regimes, the SAFEMAX even goes down when we move to the lower CPI regime, exactly contradicting much of the Bengen intuition of lower inflation leading to higher SAFEMAX estimates.

Bengen SAFEMAX values for fixed CAPE ratios but for two different inflation regimes. Source: “Choosing The Highest Safe Withdrawal Rate At Retirement”, Oct 1, 2020, Note: if a CAPE number was at the border of two CAPE buckets (e.g., CAPE=16 and the bins were 14-16 and 16-18) then I use the mean between the two CAPE bin SAFEMAX values.

So, moving between those two inflation buckets, gives you essentially zero impact on your SAFEMAX (-0.03% on average), even though you move the CPI by a whopping 2.5 percentage points.

Even when considering the entire range of the CPI buckets you rarely get a noticeable difference in the SWR for a fixed CAPE. For example, for CAPE=15 you get a SAFEMAX of 7% in the lowest CPI bucket and 6% in the highest CPI bucket. The mean CPI annual rate in those buckets was -9.3% and +6.5%, respectively. If you spread out that 1% gain in the SWR over a 15.8% decline in the CPI you get a “slope” of about 0.063 per percentage CPI point. In the same ballpark as the 0.04 to 0.05 CPI betas I estimated above in the 1y vs. 30y inflation scatterplots. How can a tiny drop in the inflation rate justify raising the SWR to 5% or even 5.5%?

Problem 5: Ignoring modern statistical data analysis techniques

One problem that immediately jumped at me when I saw all the tables in Bengen’s FA article: When you start with the historical retirement cohorts and you sort them and put them into different bins along two dimensions (inflation and CAPE regime), you might end up with very few observations in each bucket. How many of the findings are actually statistically significant? I took the time to calculate the number of observations in the following buckets:

  • 7 CAPE regimes <12, 12-14, 14-16, 16-18, 18-20, 20-22, >22, roughly in line with most of the bins used in Bengen’s paper
  • 6 inflation regimes as in the Bengen paper: <-5, -5 to -2.5, -2.5 to 0, 0-2.5, 2.5-5, >5

The number of cohorts starting in the various buckets are in the table below. Do you notice a problem here? Even though we have 768 total observations (cohorts starting retirement between July 1926 and June 1990), the number of observations gets very sparse in most of the buckets. Sometimes down to zero. So, if someone shows me SAFEMAX rates that differ by about a whole percentage point when going from -5% inflation to +5% inflation I wonder if this is just spurious. Can Bengen quantify his confidence in any of his numbers?

The number of cohorts starting retirement in various CAPE/Inflation regimes.

But it gets even worse. Someone might argue that even for the high-CAPE regime (>22) we do have 10, 35, and 11 observations in three different inflation regime bins. It’s a low number, but it’s something you can work with if you know your statistics. But there’s a catch. Let’s look at how the 10+35+11=56 observations are distributed over time. In the chart below, I plot the entire SWR time series for the 30/20/50 asset allocation and I mark in blue, green, and maroon the three different inflation regimes for the CAPE>22 buckets. Notice something? Even though we have 56 different observations they all cluster around the three market peaks, 1929, 1937, and the 1960s. These are not all independent observations because most of the return data windows overlap here. So, the number of true observations just went from 10, 35, and 11 in the three bins to 1, 3, and 2 if we kick out the observations that are not truly independent. With such a low number of observations, we’re entering statistical la-la-land if we want to draw sweeping conclusions like raising the safe withdrawal amount by a whole percentage point!

Safe Withdrawal Rates 1926-1990. The cohorts in the high-CAPE regime are marked in blue/green/maroon to distinguish the three inflation regimes.

To get a handle on how much of the inflation story in Bengen’s paper actually holds water from a quantifiable, statistical point of view, I propose the following: We run a regression to find out how much of the variation in SWRs is explained by the CAPE and the inflation rate. And is the inflation-beta even statistically significant? Granted, the regression analysis does not exactly generate the SAFEMAX/failsafe we’re interested in. Think of a univariate regression where the regression line goes through the cluster of points, not underneath it. But the slopes that refer to the mean/point forecast for the SWR aren’t materially different from those that apply to the tail estimates. (more details for the stats wonks: the out-of-sample point forecast moves linearly according to the betas, of course. The variance around a forecast for out-of-sample independent variable x0 is s^2*[1+x0’*inv(X’X)*x0], and will change for different value of x0 but only very little for the CPI values that we’re interested in, say, between 0% and +5%)

The regression results are in the table below. Obviously, the earnings yield (=the inverse of the Shiller CAPE) has very meaningful and statistically significant explanatory power for the SWR. But 1-year trailing inflation is again both statistically and economically insignificant! The t-stat is only about 1.25 and the magnitude of the slope is so low that going from one CPI bin to another doesn’t seem to make much of a difference. Going from the 2.5-5.0 bin to the 0.0-2.5 bin would warrant a 2.5×0.019%=0.05% higher SWR. And of course, we knew that already, even from Bengen’s own data!

Regressing the SWR of a 30/20/50 portfolio on an intercept, CAEY=1/CAPE, and 1-year trailing CPI. The t-stats are Newey-West heteroskedasticity-adjusted. Not much explanatory power from CPI here!

And by the way, when I say modern data analysis tools, I don’t even mean anything really modern. The concept of regression analysis has been around for about 100 years. The seminal research by Whitney Newey and Ken West to adjust t-stats for heteroskedasticity was published in 1987 – before some of the readers here were born. So, not exactly rocket science. But it certainly beats bumbling and fumbling around SAFEMAX guesstimates in the 38 different bins when most bins have only between 1 and 3 true, independent observations! 

Problem 6: Data-snooping

Initially, I had trouble wrapping my head around some of Bengen’s results. Why is the failsafe withdrawal rate (SAFEMAX in his nomenclature) so high right now? But then I read more carefully and found the explanation; Bengen writes in the FA-mag article

“I ignored data for which the 30-year price-earnings ratios were 30% more or less than the long-term average of 17.05; in other words, I anticipated approximate reversion to the mean of the Shiller CAPE. I felt that much larger deviations created unrealistically high or low safe withdrawal values. Even so, my permissible 30-year CAPE ratio has a wide range, from approximately 12 to 22.”

Okkkayyy? The only problem with this approach is: We currently do have a CAPE significantly more than 30% above the long-term. At the current level of about 30, we are a cool 75% above the long-term average of 17. Why would I want to ignore previous market peaks at which we had similarly overvalued CAPE ratios? It’s like you want to estimate the probability of rainfall but you ignore all prior historical data when you had cloudy skies. And then you apply those probabilities to a situation today when you have some dark clouds rolling in and you can hear some thunder in the distance already. What use is that forecast?

But I don’t want to rub in this issue too much. Maybe Bengen just misspoke (miswrote?) on this issue because in Figures 8 and 9 he does have categories “22 or Greater” and “23 or Greater” for the CAPE bins. So, maybe he does factor in the high CAPE ratios. For example, he also seems to concede that a 4.5% SAFEMAX was necessary during the high-CAPE regime in 1968. And again, with my own calculations, I find a 3.88% failsafe (Dec 1, 1968 cohort), even when using the 20% small-cap stocks, much lower than his estimate. But even if Bengen operates with a 4.5% SAFEMAX in 1968 when the CAPE was 22.2 (Nov 30, 1968), how can he then recommend 5% or even 5.5% today when the CAPE is standing at 31, almost 50% higher than in 1968?

Bengen seems to suggest that because the previous SAFEMAX low of 4.5% occurred while the CPI was in the 2.5-5.0% range, we can now completely ignore today’s high CAPE ratio because we’re in the 0.0-2.5% CPI range. I find this claim almost as offensive as completely ignoring the CAPE>22 observations. For all the other CAPE ratios (14, 16, 18, and 20) moving between the two inflation bins had essentially zero impact on the SWR, ranging from -0.25% to +0.25% with an average of -0.03%). But for a CAPE just 2 points higher (22 in 1968) then suddenly the inflation regime makes a tremendous difference of a whole percentage point? That sounds really odd. 

Why does the inflation regime have essentially no impact on the SAFEMAX for low CAPEs but a huge impact when the CAPE is above 20?

Think about it this way: the fatality rate while climbing K2, one of the deadliest mountains in the world is almost 30%. But there have been zero fatalities among 6’6″ tall German-Americans from Camas, Washington on that peak so far. So I can just start tackling a summit push on K2 without any risk, right? Uhm, no! You can always slice and dice away previous disasters by inventing artificial and arbitrary additional constraints and eliminating some or even all of the data points that don’t fit your message. But you can’t slice and dice away the underlying fundamental risk. Just like you can’t eliminate the risk of a high CAPE ratio by pointing out that today’s CPI environment is different from 1968. One shouldn’t do that when the CPI has a very spurious relationship with SWRs in the overall sample.

Problem 7: Not even the 30-year “perfect foresight” inflation number would have helped you that much in pinning down the SWR!

As we saw in the plot above, the 1-year trailing CPI inflation number is pretty much uncorrelated with the safe withdrawal rate (SAFEMAX) over the next 30 years. There’s just too much noise in annual CPI numbers in the historical data. But let’s do a thought experiment to really drive home the futility of linking SWRs to inflation. Imagine all of the historical retirement cohorts had known for sure(!) what’s the realized annualized CPI inflation rate over the next 30 years. Then how much would that have helped in pinning down the safe withdrawal rate? Let’s run the same SWR linear regression as above, with the SWR as the dependent variable and a constant, the CAPE earnings yields, and the 30-year ahead perfect foresight CPI inflation rate (annualized). Would that be picked up in a statistically meaningful way? Let’s take a look at the regression results. I do this for three different dependent variables, i.e., the historical SWRs for the Bengen 30/20/50 Portfolio and but also without small caps just for the 50/50 and 60/40 Stock/Bond portfolios. The results are in the table below: 

Regressing SWRs on initial CAEY and perfect-foresight future 30-year CPI annualized inflation rate. 1926-1990 with small-cap, 1872-1990 for the 50/50 and 60/40

So, even if you could have perfectly estimated the future annualized CPI rate over the next 30 years, you can’t raise your SWR one-for-one. You can increase your SWR by between 0.25 and 0.54 percentage points for every 1 percentage point reduction in the annual inflation rate. The R^2 goes from 0.673 in the baseline regression using trailing CPI to only 0.795. The CAPE earnings yield is still the overwhelmingly important factor in accounting for the SWRs. That’s quite amazing considering the CAPE is actually known at the start of retirement, while the 30-year CPI number is not! The punchline here: don’t even attempt to read much into different inflation regimes. Even if the future inflation rate is lower by x%, you can’t take the entire x% to the bank and translate that into an x% higher SWR!

Problem 8: Don’t put the nominal cart in front of the real horse

The logic “lower inflation implies higher withdrawal rates” doesn’t hold up in the data as we saw in the calculations above. That’s odd! Remember, there is the Fisher Equation:

Real Return = Nominal Return – Inflation

Isn’t that the definitive proof that the real return should move one-for-one (or one for minus one) with inflation? Inflation goes down by a percentage point, then the real return has to go up, right? Wrong. It’s only true if the nominal return doesn’t change in response to the lower inflation. But that’s not guaranteed!

Look at the following prominent example where inflation went down and you clearly didn’t get to pocket a nice fat raise in real returns. In the early 1990s, Brazil had double-digit inflation. Every month! Which translated into about 4,000-5,000% annualized inflation. Sure, the equity returns were pretty impressive, around 7,000% year-over-year in 1994, but unfortunately, a lot of that came just from the inflation mirage. And of course, we all know what happened. Brazil got its act together, cleaned up its monetary policy, and achieved single-digit annualized inflation for almost the entire next 25 years (only two short stints with Y/Y inflation slightly above 10%). So, according to Bill Bengen’s logic, could people have retired in 1994 with a 7,000% annual withdrawal rate? Hey, inflation went down, right? Unfortunately, nominal returns went down, too. Who would have thought?!

Brazilian Equity returns and CPI. Just because CPI goes down, doesn’t mean your real return goes one-for-one! Sources: Yahoo Finance. Organization for Economic Co-operation and Development, Consumer Price Index: All Items for Brazil [BRACPIALLMINMEI], retrieved from FRED, Federal Reserve Bank of St. Louis;, October 23, 2020.

So, this case study from Brazil provides a stark example of a simple economic fact: real returns, especially real equity returns are often tied to real economic fundamentals: productivity growth, population growth, etc. If we move to a different inflation regime you don’t necessarily get to pocket the entire difference in inflation as a guaranteed boost in the real return.

It’s also possible that real returns stay roughly the same and nominal returns just move hand-in-hand with the inflation regime. True, Brazil probably noticed a bit of a boost in real productivity in light of getting its macroeconomic policy act together. But I have a hard time rationalizing how a move from a 2% trend inflation to 1.4% inflation provides much of an economic game-changer. If anything, I’d be more concerned about lower real growth prospects in most of the developed world going forward, in light of rising debt levels and the resulting political uncertainty, rising inequality, etc.

But just to be sure, I’m also the first to concede that low and stable inflation is generally a good environment for real bond returns and even stocks. So, I’m not surprised that there’s a slightly positive slope between realized inflation and your SWR, as we saw in the regression above. But again, the relationship is not 1-for-1. The concern I’d have for bond investments, in particular, is that we’ve already had very low and stable 2% inflation for the last 20 years. Significantly below 2% over the last 10 years. A low inflation regime is already baked into today’s asset valuation landscape. How much lower are we going to go to pump up bond returns much more? How about the risk of all that debt blowing up in our face and creating a huge inflation wave over the next 30 years? Then we might even be grateful that the beta is lower than 1 and we don’t have to reduce our SWR one-for-one if future inflation goes through the roof! 

Problem 9: Not seeing the forest for the trees.

Independent of the analysis above, the whole idea of a 5.5% safe withdrawal rate in today’s environment just doesn’t pass the smell test. Here’s another way to illustrate how dangerous the 5+% safe withdrawal rate is in today’s financial environment. You have a 50% bond share. Current Treasury yields are well below the inflation rate. For example, the nominal 10-year yield was 0.841% as of Friday, October 23. The most recent 12-month rolling CPI inflation rate was 1.41% (9/2020 vs 9/2019); a real yield of around -0.57% based on trailing inflation. The current TIPS yield is even worse: -0.89%, which seems to indicate that the financial market 10-year inflation forecast is actually a bit higher than the 12-month trailing figure.

If 50% of the portfolio has a negative real yield, your equity portfolio has to do double-duty. How likely is that with a CAPE above 30? So, in other words, you can slice and dice all your historical data any way you want and hide the historical bad Sequence Risk episodes of cohorts that retired during high-CAPE-ratio regimes. But you can’t escape simple math. Today, you’d need significantly above-average real equity returns to make this work, which seems highly unlikely when the CAPE is 75% above its long-term average. I’m not saying that above-average equity returns are impossible, I’m just saying that, historically, that’s how returns and valuations in equity markets have worked out. When I calibrate a Safe Withdrawal Rate, the emphasis is on the word “Safe”. Setting your withdrawal rate to something you “hope” might happen if you get lucky over the next few decades is not a SAFEMAX. It’s a HOPEMAX


The Bengen Study in the FA-mag and the follow-up interviews on and MarketWatch have not convinced me that we can materially increase our Safe Withdrawal Rate. First, and that’s a bit of a side-issue, small-cap stocks might have given you a bit of a return boost between 1926 and 1980. But you’d be best served not taking that for granted going forward, because a) the small-cap outperformance party might be over now and b) even for some of the earlier retirement cohorts (e.g. Nov/ Dec 1968), the Fama-French SMB bias didn’t give you a very consistent boost in your failsafe rate.

Secondly, and most importantly, the low-inflation story doesn’t make any sense. A lot of people reached out and asked me for my opinion and I’d normally give a quick response in line with item #9 above. But I thought it’s worthwhile to do a more careful analysis and see where the skeletons are hidden in Bill Bengen’s study. The connection between 12-month CPI and future 30-year safe withdrawal rates is just too spurious.

Of course, as always, I want to point out that in some of the case studies I’ve done, I’ve routinely recommended initial rates of 5% or even 5.5% for early retirees who have to bridge only 10-15 years until generous pension and Social Security benefits start. But as a baseline over 30 years of flat withdrawals, I’d find 5% and especially 5.5% really irresponsible. And the recommendation of 50% bonds and 5.5% SWR would be particularly irresponsible for my friends in the FIRE community with a retirement horizon of 50+ years. 

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!

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67 thoughts on “Can we raise our Safe Withdrawal Rate when inflation is low? – SWR Series Part 41

  1. Interesting as always. Small Cap just seems to be stock picking in my opinion.

    I think I will stick to 3.25% WR. If it turns out to be north of 5% then my daughter will have more when I leave this mortal coil.

  2. I knew it was just a matter of time before you had your counterattack post on this 5% figure. Thank you as always for highlighting the facts with thorough analysis and charts. The Bengen article has been circling around in my little FIRE bubble so I’m happy to share this as the counter attack. I’ll stick with a sub 3% withdrawal rate and be happy knowing I’m likely going to leave more for my kid(s) than need to rely on them in my older years.

  3. Excellent systematic deconstruction. I read Bengen’s recommendation and scratched my head. He lost me at real vs nominal. At one point he made the observation that many of his retiree clients had done substantially better (bc the bull market) than expected. The suggestion (as I heard it) was that this might support his claim. But of course that shouldn’t affect the SWR. I can stop scratching now.

  4. So I have read the 4% rule for years and can to a different conclusion years ago. Why would I put half of my funds in bonds and make so low on interest? I plan to keep 100% in stock, yes they are volatile but it is nothing different that what I deal with now. With 2M I can safely withdraw 120k-150k a year and In 30 years I would still have more than what I started with.

    1. I can’t endorse a 100% equity portflio and 6%-7.5% withdrawal rate either. At 6% you would have run out of money after less than 15 years in the bad Sequence Risk episodes (1929, 1968, 2000). With 7.5% WR even faster, sometimes in less than 10 years.

  5. So the enemy of higher SWRs is SOR risk particualry in early years. Poor real returns in early years might be as a result of poor nominal returns (falls) in stock prices or/and high rates of inflation. Inflation that is low, and based on bond prices forecast to stay low, takes one half of the risk out of that equation.

    Or alternatively you could go high cash percentage in the early part of retirement because you are trading off less inflaiton risk against potentially lost stock market gains; lower volatility in the early years = less SOR risk = higher SWR all other things being equal.

    1. I don’t really agree. There are two situations when inflation can be high over some period

      1) inflation was expected to be high at the start of the period, as is priced into asset prices (especially higher bond yields/ interest rates)

      2) inflation was initially expected to be low but then turned out to be high. This one is very dangerous for anyone with a significant bond or cash allocation as the interest rate will be too low to compensate for that higher inflation. (real assets like stocks can hope to keep pace with higher.)

      Given that situation 2 is a much greater threat than situation 1, I have a hard time seeing how todays low inflation/ low interest rate environment can be comforting. If anything todays low inflation + low rate environment is more dangerous than ever!

      1. Yes, Yes, Yes!!! That’s a very good point. The absolute level of inflation is less important than change in the inflation regime. It’s like with bond returns where the different in yields creates the duration effect.
        And that’s a the great headache. After such a long run of low inflation, I’d be more concerned about a reversion to slightly higher rates, with some really nasty consequences on the bond market. (I tried to make this case in the last paragraph in Section 8)

        1. Yep, I strongly agree with what you wrote in section 8.

          It think it’s a mistake to think about nominal returns and inflation as if they were two independent observations when they really ought to think about real returns on real assets (and inflation surprises rather than levels impacting fixed income investments.) I was pretty surprised to hear someone as respected as Bengen making these sorts mistakes, glad that you are here to set him straight!

      2. Regarding situation 2 above, what if stocks have a CAPE of 30 like now? Then future returns likely low, or negative? There used to be an old heuristic, 20 – inflation rate = appropriate market P/E (not CAPE). e.g. 20 – 2% inflation = an 18x P/E. says current 10/29/2020 trailing 12 mos P/E = 33.36x. What would bringing the market P/E down from 33.36 to 18 do to the next 10-year returns? That’s the dilemma.

        1. I agree that market valuations are concerning and are a good argument for setting a conservative withdrawal rate, but I don’t agree that inflation has anything to do with it. I have never hear that heuristic but I don’t think its correct, the problem being that equity returns are not just about current earnings but earnings growth.

          Inflation means that companies will raise their prices resulting in higher nominal (not real) earnings growth. This means that share prices should grow faster in high inflation environment in nominal terms (see point 8 in the original blog post). This means that real equity returns are not very sensitive to inflation rates over long periods of time. The exception being if inflation rates are either so high that they damage real economic growth, or if there are severe underlying supply side issues that both damage the economy and result in inflation (ie oil shocks).

          If you are buying a stock, you are buying a real asset, a stake in a company, which has inherent value which is separate from the price level of the dollar.

          1. Very well said. In that sense, inflation is irrelevant to future earnings.
            For full disclosure, short-term inflation shocks can be negative for stocks, but medium/long-term your exact argument applies. 🙂

          2. Well, I think that historical data shows that inflation definitely impacts asset prices / valuations, i.e. P/Es. Rising inflation, caused to a significant degree by Vietnam War, expansion of Great Society welfare-state programs, and Mid-East oil-supply shocks, from the mid-1960s through early 1980s, definitely played a role in declining P//Es same period. Stock market real return during this period was poor, basically sideways. I would have to say that mid-1960s through early 1980s is long-term. By late 1970s single digit P/Es. I wish I had bought. The next time this happens please remind me to buy. 1979 Business Week headline: “The Death of Equities.” The 20 minus inflation rate rule of thumb was attributed to Peter Lynch, a famous well-respected money manager at that time. He’s still a legend at Fidelity. Okay, I’m showing my age. Lower inflation since that time, higher P/Es. But of course inflation is only one of many factors affecting valuations. Higher P/Es also caused by better technology, better software stock research tools that make markets more efficient, i.e. small low-P/E ignored companies can’t stay ignored by investors as long as they used to, more investor education, i.e. more people know they need to save and invest for the future, 401ks / IRAs thus adding to investor demand for equities and pushing up P/Es, 1975 deregulation of broker commissions probably lead to more retail investors (I’m showing my age again), discount broker accounts with everyone on their laptop at the kitchen table trading stocks probably pushes up P/Es, more conservative GAAP accounting rules / earnings reporting lowers the E in the P/E. And I think another heuristic, “Don’t Fight the Fed,” which some attribute to Martin Zweig, another famous money manager from back in the day, is the one investors are following now, leading to higher P/Es.

            1. I agree that very high inflation can be bad for economic growth and therefore to stock returns, but it’s far less than 1 for 1. I also don’t think that applies to a shift in inflation from 3% to 1%: if anything a super low rate of inflation is also bad for (real) economic growth.

              I also question the causal link- bad policies and global events hurt growth in the 60’s and 70’s and also led to a very high level of inflation. There are other periods when bad policy has led to very low levels of inflation or deflation which was also bad for real growth and stock returns.

              You agree that the low p/e valuations in the late 70s seem to have been a mistake, but I wouldn’t count on markets making that particular mistake next time! Markets are more sophisticated today.

              Many of the factors you are citing that drive p/e ratios are ones that I was considering as influencing the “supply vs demand of savings and attractive investment opportunities” I referenced my other comment. But agree that there are a lot of factors.

              I am not familiar with the original context of the ‘don’t fight the fed’ comment, but these days most investors would associate that with the effect that expansionary monetary policy has in boosting stock prices, suggesting that equities are indeed widely seen as an inflation hedge. Excessively low inflation is bad for real growth too.

        2. the correct P/E ratio is about the supply vs demand of savings and attractive investment opportunities. In a world with high P/E ratios saving for retirement will be very expensive. I think that the ‘correct’ P/E ratio is unrelated to inflation.

  6. Hi,
    What would be your suggested SWR for someone retiring today at the age of 40/50/60 and let’s say they are willing to risk 10% probability of “failure” ?

    1. I have a Google Sheet, see Part 28, where you can play around with different asset allocations, supplemental cash flows, horizons, etc.
      And then you can see what’s the initial WR that targets different failure probabilities, incl. 10%

    2. A 5% WR rate works over 80% of the time (~85%, IIRC)

      One prominent retirement writer (Bengen himself?) argues any “success” over 80% is meaningless since that last 20% of risk one will face over a 30 year retirement (wars, etc.) simply can’t be modeled financially.

        1. Thanks for the link. As I mentioned in my other reply: We should all recognize the possibility of “future will be different” so even a 100% safe historical simulation could be only 80% if considering all other uncertainties. That does not mean you should target only 80% success rate a priori, because that rate will be further reduced by compounding all the other unknown unknowns. I think Bernstein is not very logical with his statement. But I will leave it at that. It’s enough to offend one big guy in the industry at a time. 🙂

          1. IIRC, Bernstein’s “Retirement Calculator from Hell” series was written between 1998 and 2003. A punchy summary of each part [five in total] is given at: and that link also provides links to each of the WB originals. Perhaps, reading them as a series – with an eye to when they were written – would help.
            IMO quantifying (or more often, completely ignoring) just how big a deal unknown unknowns may be is a big failing of all, so-called, SWR methods. IMO, all WB was doing in his Part III was trying to put an estimate to this level of uncertainty.

      1. Not true.
        If I use my basic 60/40, 0% final value, 30-year horizon I get the following failure rates:
        All cohorts: 25%
        CAPE>20: 40%
        CAPE>30: 47% (today’s CAPE=31!!!)
        S&P500 at or near all-time-high: 30%
        So, not sure where your numbers came from, but you can check mine in my Google Sheet.

        I think the way Bernstein probably meant his 80% number is that, even if in historical simulations you get a 100% success rate, you’d still need to budget for the SHTF, future will be different scenario. So even a 100% safe WR historically, can only be called 80% going forward.
        So, if you tell me you’re OK with 80% historical, that means it’s only 60% (or 64% of compounding 0.8×0.8) success rate. Not enough for me. Maybe for other folks.

  7. Isn’t the bigger issue with SWRs the extreme volatility of equities, which is great for the accumulation phase but not the withdrawal phase? Do you have an analysis of holding a more balanced portfolio of stocks, US Treasuries (some long term), Gold and REITS or Real Estate, for example, to reduce volatility and increase the SWR? It seems that the standard stock / bond mix is limiting options for better results.

    1. Throughout the SWR Series I’ve looked at different Stock/Bond ratios and found that you certainly need a bit in bonds to balance the vol in the short-term. 100% stocks is very risky!
      It’s also beneficial to start with a high bond share and then move more into stocks (Parts 19/20).
      I studied gold in Part 34. It has some diversifying effect but it’s not a pancea.

      1. Big Ern, thank you for contributing so much to the early retirement community with your SWR studies and content. Amazing work! I struggle to follow you in one specific area, the actual monthly withdrawal, and the monthly rebalancing of the portfolio. Specifically, with these big swings in the stock market, how would you suggest rebalancing the portfolio? Say at the end of month x you have withdrawn your monthly Dollar amount (as per the failsafe withdrawal calculation) and the portfolio shows exactly the targeted stock/bond weight. It just happens that in the following month, the stock market falls 30%. What would you withdraw at the end of that month? I assume you would take everything from the bond side of the portfolio to help with the rebalancing of the portfolio. But because the drop was so significant, it is out of the targeted balance. Would you now go ahead and rebalance the portfolio to bring it back to the targeted stock/bond weights (could be done in a 401k/IRA type of account)? If not at the end of the month, after six months (you had another blog post that went into this topic in more detail)? I guess the same question goes for the way up when stocks recover. The nature of my question really is about whether the SWR really requires to be hands-on every month (or every quarter, or six months) for it to work as per the SWR calculations? Thank you und viele Gruesse von einem Schweizer der auch schon laengere Zeit in the USA lebt.

        1. Great question. And you are in luck because I answered that question:

          Punchline: you can certainly get away with less-than-monthly rebalancing. Less frequent even gave you a very minor advantage around some of the big tuning points.

          Viele Gruesse! Ich habe Verwandtschaft in Konstanz in Deutschland und bin dann auch haeufig in der schoenen Schweiz! 🙂

  8. I can’t speak for Bengen but maybe he makes the simplistic assumption that high inflation would result in higher interest rates which would juice up bond returns. Even if we ignore the real and nominal issue; we could have a scenario where we get inflation but interest rates don’t rise.

    In the current MMT scenario; I am more worried about inflation. Especially as I wrote about the Reserve currency Status and what impact losing it would have on the MMT world which both parties in USA seem to embrace.

    1. Well, if inflation goes up, rates go up, which is good for bonds in the long-term. But short-term bonds will get hammered. Which is bad news from Sequence Risk perspective.

      Personally, I’d think that MMT as much as I dislike it has only one change of working: if we DO get some inflation and eliminate the debt burden that way. The worst case outcome for MMT would be sclerotic growth and deflation, a la Japan.

  9. Great article as usual!

    To nitpick a bit, I find a bit of fault with your comment of “But you can’t escape simple math.” This is not “simple math” for most of us mere mortals. Thanks for doing the heavy lifting!

    Another example of why this is the best FIRE blog by far for those interested in the numbers.

  10. Another great post, Karsten.

    Aside: I wish you’d do some further postings on the actual withdrawal mechanics scrutinizing them. The SWR side of things and the pre-retirement phase has so, so much content right now but the other side of things still suffers.

    I’m very curious about a few things – the impact of imposing a floor (minimum budget) on CAPE10-based withdrawal approaches, considerations of non-discretionary expenses (medical) starting at some age; combining these with the specifics of drawdown – for example, comparing active rebalancing [draw out and _additionally_ rebalance, especially in a taxable account], passive-WR-based rebalancing (use the withdrawal to steer toward desired balance – for a low enough WR, this is a very slow process that may never catch up, but does it matter?), and schemes like Bonds First / Omega Not.

    An example question: could one get away with a CAPE10-based WR, with some (constant dollar) floor, and just bonds first strategy (EQUITIES%, BONDS% -> 80/20 for E,B = 50,50.. 60, 40…)?

    (A big part of my planning is making sure that if I die or am incapacitated before my wife that she will be able to execute whatever plan we use. There is some coverage of this in the book “Living Off Your Money” but it’s not at the level of quantitative analysis that you do. I don’t think enough people consider that the plan has to be simple enough that 80-year-old-you/spouse can execute it…)

    1. Well, I’ve done some simulations on the CAPE and I also include those in the Google Sheet.
      You can check if your consumption path would have ever broken through the floor you picked.
      The disadvantage of a floor is that it takes away the valuation component and by withdrawing more than proper during the bear market you would also prolong the downdraft in spending. So, personally, I don’t think a consumption floor is a panacea. It creates more headaches than it solves.

  11. If I could predict inflation, I’d make a fortune selling swaps or arbitraging treasuries vs TIPS! Forget about the SWR all together!

    I don’t think today’s combination of ZIRP, low inflation, and sky-high CAPE has ever occurred in the US. Those are 3 major factors affecting SWR, and they have room to go only in a bad direction. They dwarf any benefit from low COLAs, as you found.

    I’d be curious to know your thoughts on the optimal strategy to retire if it was 1990 and one was limited to Japanese investments and the yen.

    I’d also like to know your thoughts on Ray Dalio’s theory of imperial and reserve currency cycles, and how that perspective might influence AA and SWR calculations.

    Both of these ideas are ahistorical for the US, and they lead long term inflation projections in very different directions. The Japanese, despite the predictions of classical economics, got disinflation. The British pound OTOH got devalued in the 60s.

    1. Thanks! We share the same concerns. These are very challenging times. Even if I calibrate my SWR to historically safe levels, there is significant risk that things will be a lot uglier going forward.

      That said, I don’t really listen very much to Dalio or many other Wall Street personalities. He seems like he has a public opinion and a private opinion (what Bridgewater ACTUALLY trades) and you never know if what he’s pushing publicly is what he really believes in or if he’s trying to find suckers to take the opposite side of Bridgewater’s bets.

      1. Fair enough, but every academic or blogger also has an agenda, and each of us have our own biases. Theories should stand or fall based on the quality of their evidence and reasoning, not information about the source. The historic/macro picture is probably at least as hard to get right as inflation predictions and yet it means everything.

        1. I may have my biases, Bengen has his. Bengen’s bias may be to come up with bombastic exaggerated SWR to grab the headlines. What do you think my bias is? Telling people “No, you can’t raise your SWR to 5.5%” is not a great selling point.

  12. Great piece. And I think most of your criticisms are entirely valid, and the recommendations of 5%+ WR, let alone SWR, extremely risky.

    That said, the one place IMO you are being unfair to Bengtsen is the comparison to 1 year trailing CPI as having anything to do with it. The fairest comparison it seems to me would be with forward-looking inflation expectations, as determined by long-term bond yields versus TIPS yields.

    And in fact your “Problem 7” point seems to confirm that low long-term inflation does correlate relatively positively with higher SWRs. So *if* one is confident that long-term inflation expectations *are* accurate (based on TIPS yields), then it seems like a marginally higher SWR might be called for.

    That criticism of your otherwise fantastic piece noted, personally I am *not* at all confident that said long-term inflation expectations are accurate. The opposite, actually, is my significant fear (though of course it’s *possible* that our next 30 years look like Japan’s last 30 years…). Which is why I own a chunk of gold and of metals miners, and would not consider such high SWRs as Bengtsen seems now to be proposing

    1. Thanks for the reply. Very thoughtful. And using your approach you can still show that Bengen is still completely wrong. TIPS yields are now -0.29% for the 30Y. Pretty much the all-time-low. How can a lower real yield and an almost all-time-high CAPE entice me to RAISE my SWR?

      1. Not disputing that raising SWR seems nuts. But if one takes the implicit inflation rate that TIPS reveal as “gospel” – along the lines of your “perfect foresight” analysis – then you seem to have shown that one *can* raise the SWR *some*. Just not as much as Bengtsen seems to suggest. After all, as you point out in other posts, even a 0.25% increase in SWR is a pretty big deal.

        I doubt you have anywhere near sufficient history for data on 10 or 30 year forward inflation expectations to do that modeling to test what is a much more reasonable/charitable view of WB’s thesis, as opposed to using the one year trailing CPI that you did, which was obviously gonna be meaningless.

        And to repeat, taking it as a given that we are about to become 1990 Japan, near zero inflation “forever” – while no doubt *possible* – seems a bit of a stretch. Though like another commenter, I too would love to see you work your numbers magic with Japan-only data in terms of SWRs in that low-inflation environment.

          1. Thx for the link, Al. But that one says nothing about Japan’s last 30-40 years, only that a Japan-only investor woulda been screwed pre-WWII. Shocking!

            I finally read Bengen’s piece completely through, and his *analysis* is nonsense, as BigERN notes from Problem 6 and Problems 3/4 above. But ERN’s analysis in response now has me wondering if SWRs *can* be a bit higher in a low inflation (as measured by TIPS, not 1-year trailing inflation) environment, especially if using short-term bonds/cash in place of intermediate bonds – which is my personal inclination anyway.

            But wondering is different than believing, let alone knowing.

            Thx again for debunking Bengen’s new piece. IMO it is sad and probably dangerous that the father of the still-useful (despite its imperfections) 4% rule and research is advocating such insanely high WRs as “safe”. In that context, this may well be the most important piece BigERN has ever written.

        1. Yeah, very good point. As a retired economist and forecaster I would not want to make a definitive statement on any macro variable 30 years out. The fact that Bengen kinda wants to do that amde me roll my eyes. So, the point that the perfect foresight slope is in fact positive is moot.

          And just for the record: I most definitely hope that we don’t go into Japan-style deflation/disinflation because that’s certifiably poison for asset returns and SWRs.

  13. With the super low bond yields and sky high CAPE I’m back at the 0.5% withdrawal rates and earning income on the side until either: my property income is covering expenses or the CAPE amd bond yields start to reflect safer (median) rates. I feel like otherwise I’m taking huge SR risk because of potential equity corrections or bond defaults/inflation.

    Short answer, It feels like there is 0 margin of safety in any assets at this stage.

  14. Sometimes I feel like Bengen plays fast and lose with much of this due to a factor he doesn’t generally discuss. In the beginning I believe he said he picked the 30 year timeframe considering someone retiring at 65, knowing planning for living to 95 would be very conservative. Or at least that how I originally learned about the study, and it was this fact that made the conclusions ridiculous to me. He was saying I could draw 1/25th adjusted with inflation each year from the age of 65 and not run out of money? That seemes so underwhelming to me I didn’t see the point in taking all the risk in the stock market (why not CDs or TIPs or the like), precisely because the perceived odds to me of living to 95 (or even past 80) seem so low we’re only talking about 15+ years, and definitely 25+ years a tiny percentage of the time. I would have zero problem taking 5%SWR starting at 65 not because I love the 30 year history of that in absolute, but because the failure rate of that is minuscule in comparison to the odds of me dying before that failure. When I started considering retiring in my 40s was the point these SWR studies then became interesting to me, because I see their failures as happening soon enough to matter.

    If I was gonna plan to retire at 65, with the guaranteed income of SS supporting much of my needs, and me not considering a 30 year future as a likelihood, I’d be constantly finding reasons to push the rate to 5 or 5.5% as well to try to actually spend some of that money while I’m still around.

    1. Yeah, good point! At around the time the Bengen and Trinity 1.0 were written, bond returns were high enough, you could have hedged the entire 30-year horizon with a bond ladder, (TIPS ladder post-1997) and a 5+% SWR.

  15. “One-year trailing inflation is not a very good predictor for inflation over the next 30 years!”

    Without making the same mistake to assume 2021 inflation has predictive value for 2022-2051, I still think it’s safe to say that this post has aged well!

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