Common Sense and SWRs
I put up a post yesterday in which I argued that the results that you get from use of the Data-Based SWR Tool are generally in line with what you would get by taking a common-sense approach to formulation of your investment strategies. After putting up the post, I thought about it some more, and the more I thought about it, the more strongly I felt that one of the problems in many of our SWR discussions of the past has been a failure to explain what the numbers mean in common-sense terms.
I considered putting together a post aimed at summarizing the most important findings that we have come to at the SWR Research Group board (at NoFeeBoards.com) in common-sense terms. Then I remembered that JWR1945 had already done this a long time ago. His doctor once asked him what he had been doing with his time since retirement, and JWR1945 told him about the research he was doing for our community. The doctor showed interest, so JWR1945 wrote up a short summary of some our most important findings of recent years.
Set forth below are excerpts from the summary that JWR1945 prepared for his doctor (with an occasional update added by me):
What is new?The investments available during the historical period no longer exist. Stock prices are well above the historical range. Stock dividend yields are well below those of the historical period.
What have we learned? We can now identify the cause-and-effect relationships behind the old numbers. We know what causes retirement portfolios to fail and how to prevent it. We can spot problems very early. This allows us enough time to react. If we were to stick with the old guidelines without making any kind of adjustment whatsoever, you would have to reduce your withdrawal rate to 2% to maintain a high level of safety. We know how to look at investments other than the S&P 500 index. We have more flexibility.
What causes retirement portfolios to fail? Selling lots of shares when prices are low. Volatility is the killer. Another cause is not having a sufficient amount of stocks or some other growth vehicle in the portfolio. It is essential to have growth. It is not essential to have growth right away.
What prevents retirement portfolios from failing? Historically, it has been dividend yields. In the past, stock dividends have been 3% or higher except under the most extreme circumstances. You will notice that the 4% number is equal to the dividend yield plus a very small amount from selling shares. It was not necessary to sell many shares even in times of stress (the years 1959-1973 define the worst case, not the Great Depression).
What about todayís dividend yields? They are increasing. But they remain very low, between 1% and 2%. To replicate the historical pattern, you would rely on dividends (close to 1%) plus a very small amount of selling. That means a 2% withdrawal rate. [Update: The SWR for an 80 percent S&P portfolio at today's valuation levels is 2.4 percent.]
What can we do? We can now coast through some very long periods when the stock market is unattractive. With long-term TIPS (Treasury Inflation Protected Securities), which are still available on the secondary market (i.e., through a broker) but no longer available directly from the Treasury Department, we can coast through 10 or 15 (or even 20) years, if necessary, until stock prices become attractive. Current yields are around 2.8% (the principal amount matches inflation so that the interest matches inflation as well). That keeps your principal close to 80% of its initial value for 15 years. Historically, that has been long enough for stocks to look attractive once again. [Update: TIPS yields are lower today. JWR1945 in recent months has devoted a good bit of research to high-dividend stocks as an alternative to both S&P stocks and to TIPS.]
Isnít that market timing? Yes, technically it is market timing. But it is strictly founded on fundamental value. In this very narrowly defined sense, Benjamin Graham, Warren Buffett and Sir John Templeton have all engaged in market timing. Prices do matter.
Why didnít the studies suggest this long ago? Todayís market differs from the past in a very specific way: the non-volatile component (i.e., the dividends) used to yield more than the alternatives....Today, the non-volatile component yields are much less than the alternatives.