Kitces: Preparing for Lower Long-Term Returns

[Gone4Good]

Quote:

Originally Posted by FUEGO Is this a belts, suspenders, and safety pin approach? The 4% SWR is already 95% safe and includes all the past years of high PE10-15 in the calculation to get to 4% SWR.

How many 30+ year periods in the data set start with valuations of both stocks and bonds as high as those currently? I count 0. How many started with just equity valuations above 24x? Basically 2, around 1900 and again in 1928-29.

If we're using data to project for periods where we know the starting conditions lie outside the data set then it is wise to proceed with caution . . . or, at the very least, make adjustments to bring your starting position back in line with the available data.

[newtoseattle]

I copied and pasted a table below (from early retirement extreme blog site- I hope that is not poor etiquette for blogging - not trying to "steal" anyone's hard work). rows are your net worth (i.e. 33 is 3% SWR (33 times spending), 25=4%, etc). columns are years. It shows the real returns you need for your planned retirement to last however many years. Of course, it is not accounting for any sequence of return risk. Still, I like the table and found it helpful. (i.e. so if you're counting on a 3% withdrawal rate and a 40 year timeline, you'd need 0.98% real return. if you end up living another 10 years and need 50 year timeline, then your real returns would have needed to be 1.77%)

I guess for me it means that even though real returns might only be 2%, that 3% withdrawal rate is still quite reasonable for long retirement (and even 4% swr for someone planning only 30 years)


NW 20 30 40 50 60 70 80
10 7.76% 9.31% 9.76% 9.92% 9.97% 9.99% 10.00%
11 6.53% 8.25% 8.78% 8.97% 9.05% 9.08% 9.09%
12 5.46% 7.34% 7.95% 8.17% 8.27% 8.31% 8.32%
13 4.51% 6.55% 7.22% 7.49% 7.60% 7.65% 7.68%
14 3.67% 5.85% 6.59% 6.89% 7.03% 7.09% 7.12%
15 2.92% 5.22% 6.03% 6.37% 6.52% 6.60% 6.63%
16 2.23% 4.66% 5.53% 5.90% 6.07% 6.16% 6.20%
17 1.61% 4.15% 5.07% 5.48% 5.67% 5.77% 5.82%
18 1.03% 3.68% 4.66% 5.10% 5.31% 5.42% 5.48%
19 0.50% 3.25% 4.28% 4.75% 4.98% 5.11% 5.17%
20 0.00% 2.85% 3.94% 4.43% 4.68% 4.82% 4.90%
21 -0.46% 2.48% 3.61% 4.14% 4.41% 4.56% 4.64%
22 -0.89% 2.14% 3.31% 3.87% 4.15% 4.31% 4.41%
23 -1.29% 1.81% 3.04% 3.61% 3.92% 4.09% 4.19%
24 -1.67% 1.51% 2.77% 3.38% 3.70% 3.88% 3.99%
25 -2.03% 1.22% 2.53% 3.16% 3.49% 3.69% 3.80%
26 -2.37% 0.95% 2.30% 2.95% 3.30% 3.51% 3.63%
27 -2.70% 0.70% 2.08% 2.75% 3.12% 3.33% 3.47%
28 -3.01% 0.46% 1.87% 2.57% 2.95% 3.17% 3.31%
29 -3.30% 0.23% 1.68% 2.39% 2.79% 3.02% 3.17%
30 -3.58% 0.00% 1.49% 2.23% 2.64% 2.88% 3.03%
31 -3.85% -0.21% 1.31% 2.07% 2.49% 2.74% 2.90%
32 -4.11% -0.41% 1.14% 1.92% 2.35% 2.62% 2.78%
33 -4.35% -0.60% 0.98% 1.77% 2.22% 2.49% 2.66%
34 -4.59% -0.78% 0.82% 1.64% 2.10% 2.38% 2.55%
35 -4.82% -0.96% 0.67% 1.50% 1.98% 2.26% 2.45%
36 -5.04% -1.13% 0.53% 1.38% 1.86% 2.16% 2.35%
37 -5.25% -1.30% 0.39% 1.26% 1.75% 2.05% 2.25%
38 -5.46% -1.46% 0.26% 1.14% 1.64% 1.96% 2.16%
39 -5.66% -1.61% 0.13% 1.03% 1.54% 1.86% 2.07%
40 -5.85% -1.76% 0.00% 0.92% 1.44% 1.77% 1.98%
41 -6.03% -1.90% -0.11% 0.81% 1.35% 1.68% 1.90%
42 -6.22% -2.04% -0.23% 0.71% 1.26% 1.60% 1.82%
43 -6.39% -2.18% -0.34% 0.61% 1.17% 1.52% 1.75%
44 -6.56% -2.31% -0.45% 0.52% 1.08% 1.44% 1.67%
45 -6.72% -2.43% -0.56% 0.43% 1.00% 1.36% 1.60%
46 -6.89% -2.56% -0.66% 0.34% 0.92% 1.29% 1.53%
47 -7.04% -2.68% -0.76% 0.25% 0.84% 1.22% 1.47%
48 -7.19% -2.79% -0.86% 0.17% 0.77% 1.15% 1.40%
49 -7.34% -2.91% -0.95% 0.08% 0.69% 1.08% 1.34%
50 -7.49% -3.02% -1.04% 0.00% 0.62% 1.02% 1.28%

[Gone4Good]

Quote:

Originally Posted by newtoseattle if you're counting on a 3% withdrawal rate and a 40 year timeline, you'd need 0.98% real return.

That's probably right if you assume a constant 1% real return.

Do you know how these are calculated? I think volatility and adverse sequence of returns might bring those numbers down quite a bit.

[newtoseattle]

yes - I think you are correct. It does not account for sequence of return risk. (But, of course, the premise of the discussion was that the next 15 years would have the 2% real return)

[Meadbh]

Quote:

Originally Posted by Another Reader My takeaway from this is that it probably makes more sense to pay off my rental mortgages and lighten up on dumping money into paper asset investing, because my rental mortgages are at relatively high rates (low 5's to 6 percent). I have pensions, RMD's from inherited IRA's, and the gubmint dole known as SS as the income floor, plus the net rental income. The relatively risk free return that lowers my debt exposure is awfully enticing. Thoughts?

That makes sense to me. I have been doing likewise with a rental mortgage at ~4.17%. The downside is that the ROI on the leveraged investment decreases. The upside is a guaranteed rate of return. I don't know anywhere else you can get 5-6% these days!

[Meadbh]

Quote:

Originally Posted by newtoseattle yes - I think you are correct. It does not account for sequence of return risk. (But, of course, the premise of the discussion was that the next 15 years would have the 2% real return)

2% real return on average. The sequence of returns still applies.

[samclem]

Quote:

Originally Posted by Gone4Good How many 30+ year periods in the data set start with valuations of both stocks and bonds as high as those currently? I count 0. How many started with just equity valuations above 24x? Basically 2, around 1900 and again in 1928-29. If we're using data to project for periods where we know the starting conditions lie outside the data set then it is wise to proceed with caution . . . or, at the very least, make adjustments to bring your starting position back in line with the available data.

Agreed. We're on the ragged edge of the already thin data set, with just one chance to get it right. And the fundamental economic conditions that set the US up for world-leading growth rates for much of the reporting period (and which salvaged many previous 30+ year windows with "poor starts) are certainly not guaranteed (or even likely, IMO).
Yes, caution is warranted.

[Gone4Good]

Quote:

Originally Posted by samclem Agreed. We're on the ragged edge of the already thin data set, with just one chance to get it right. And the fundamental economic conditions that set the US up for world-leading growth rates for much of the reporting period (and which salvaged many previous 30+ year windows with "poor starts) are certainly not guaranteed (or even likely, IMO). Yes, caution is warranted.

+1

It's always possible that the 21st century ends up rivaling the 20th in terms of economic growth, but it's hard not to think that the 20th century was pretty remarkable for the U.S.

Demographics aren't as favorable. Women can't again enter the workforce for the first time. Educational attainment isn't likely to increase the way it did from the start of the 1900s. Productivity growth is currently much lower than before 1970, etc.

Oh, and valuations are much worse.

So the belt, suspenders, and safety pin plan may be what is called for. If I'm wrong, the "downside" is that I'll have plenty of cash to buy that pied-a-terre in Paris I've always wanted for my golden years. And that will be tough.

[samclem]

Quote:

Originally Posted by papadad111 And if Kitces is correct in his low growth 2% real return, then one can in effect just " spend the dividends" ... A safe withdraw rate at a low (15%) tax rate .. And the market will return enough to keep the base portfolio flat to inflation ..... In theory ... of course.

Hmmm--and if this goes on for 10 years, where will valuations be then? We're positing that stock prices stay flat in real terms, and that dividends (earnings, for our purposes here?) also stay flat at about 2%. That means valuations (stock price/avg previous 10 years earnings) will also remain unchanged at their existing high levels. High valuations = continued low dividend yields and (according to the previous history) , no realistic expectation of significant price appreciation.
If we want the flowers, we have to accept the rain. If we want higher dividend yield and (eventually) higher stock price growth, then the real price of equities needs to drop. That'll sting a bit.

[photoguy]

Quote:

Originally Posted by Gone4Good How many 30+ year periods in the data set start with valuations of both stocks and bonds as high as those currently? I count 0. How many started with just equity valuations above 24x? Basically 2, around 1900 and again in 1928-29.

I think PE10 just made it over 24 in 1966. Of course that does not bode well either as it is a failure case in SWR simulations at 4%.

What we want is the conditional probability of failure given a high starting PE10. I think 1900 and 1928 actually survive, so that leaves 1 out of 3 or 33% for a naive estimate.

[Gone4Good]

Quote:

Originally Posted by photoguy I think PE10 just made it over 24 in 1966. Of course that does not bode well either as it is a failure case in SWR simulations at 4%. What we want is the conditional probability of failure given a high starting PE10. I think 1900 and 1928 actually survive, so that leaves 1 out of 3 or 33% for a naive estimate.

You're right, 1966 squeaks in at 24.06x. 10-year treasuries were at 4.6% then, though.

In any case, we have three data samples that suggest a 66% probability of success (ignoring bond yields).

How much does anyone want to bet on the outcome of a 4th trial based on that sample set?

I bet nothing.

[Lsbcal]

Quote:

Originally Posted by audreyh1 Interesting Kitces interview at M* where he discusses the predictive capability of Shiller CAPE and points out that 15 years has the best predictive capability which happens to correspond to that initial period which can make or break portfolio survival. You can read the transcript if you don't want to watch the video Preparing for Lower Long-Term Returns

I'm convinced that the PE10 ratio has been widely misinterpreted. This is a good article which summarizes critiques of the PE10:
Article Archive

Quote:

The goodwill effect equals four points of the Schiller CAPE ratio, which drops from 24.5 under the traditional calculation to 20.6 for Livermore's version. Effectively, then, that single accounting adjustment alters the ratio's signal so that instead of suggesting that stocks are abnormally high in price, they are instead only on the higher side of normal--with plenty of history suggesting that they could move higher yet.

Quote:

...when an empirical measure begins to sputter, it's probably best to move on. It's not as if the ratio's use is supported by theory.

Swedroe also did a recent article discussing similar findings.

[Options]

Quote:

Originally Posted by samclem Agreed. We're on the ragged edge of the already thin data set, with just one chance to get it right. And the fundamental economic conditions that set the US up for world-leading growth rates for much of the reporting period (and which salvaged many previous 30+ year windows with "poor starts) are certainly not guaranteed (or even likely, IMO). Yes, caution is warranted.

In the 1970's Jimmy Carter gave his famous age of limits speech that turned out to be at least one of the reasons he wasn't reelected. It did seem at the time that he was right: America would grow no more, at least not like it had in the past. Then in the 1980's it was "Morning in America" with a turnaround unforeseeable in in the 1970's. Then in 1989 (?) it was the infamous "Death of Equities". We know how that turned out.

Predictions, even coming from someone I esteem as highly as Michael Kitces, always make me quesy. These are predictions, forecasts, and when it comes to forecasts I like everything Buffet (and a whole lot of others) has to say about them (ignore them, basically).

See this:

https://www.bogleheads.org/forum/vie...ewpost=2795523

Quote:

I started the Boglehead Contest in 2001 to show that no one can predict the stock market except by luck (or changing their forecasts :wink: ).

Emphasis added

If you've done the hard work of having accumulated a sufficient PF, lowering your AA the 5 years before/after retirement, created an ISP with a plan B, C,, and possibly D, SOR shouldn't bother you. At that point, there's nothing you can do about a bad SOR at the start of retirement anyway. As Otar says, it's the "luck factor".

[Gone4Good]

Quote:

Originally Posted by Lsbcal I'm convinced that the PE10 ratio has been widely misinterpreted. This is a good article which summarizes critiques of the PE10: Article Archive Swedroe also did a recent article discussing similar findings.

I'd like to dig into the analysis that yields this conclusion.

Prior to 2002 Goodwill was amortized annually. Now it is subject to periodic impairment tests. It's not clear to me that over time one method yields higher earnings results than the other, although it's certainly possible.

What we do know is that earnings with periodic impairment will be more volatile then when using straight line depreciation. And we have indeed seen more earnings volatility.

[audreyh1]

Quote:

Originally Posted by walkinwood Has Kitces written about the relationship between current CAPE and SWR over periods of 30-40 years? And how do you account for current bond yields in that relationship? To me, in the de-accumulation phase, that's the important data point.

Yes - he says that for 30 years the predictions are as bad as for one year - poor. In other words, not useful.

No accounting for bond yields.

[audreyh1]

Quote:

Originally Posted by Options In the 1970's Jimmy Carter gave his famous age of limits speech that turned out to be at least one of the reasons he wasn't reelected. It did seem at the time that he was right: America would grow no more, at least not like it had in the past. Then in the 1980's it was "Morning in America" with a turnaround unforeseeable in in the 1970's. Then in 1989 (?) it was the infamous "Death of Equities". We know how that turned out. Predictions, even coming from someone I esteem as highly as Michael Kitces, always make me quesy. These are predictions, forecasts, and when it comes to forecasts I like everything Buffet (and a whole lot of others) has to say about them (ignore them, basically). See this: https://www.bogleheads.org/forum/vie...ewpost=2795523 Emphasis added If you've done the hard work of having accumulated a sufficient PF, lowering your AA the 5 years before/after retirement, created an ISP with a plan B, C,, and possibly D, SOR shouldn't bother you. At that point, there's nothing you can do about a bad SOR at the start of retirement anyway. As Otar says, it's the "luck factor".

Kitces is not actually predicting - he is talking about how different indicators have worked as past predictors. That is an entirely different message.

[papadad111]

Quote:

Originally Posted by samclem Hmmm--and if this goes on for 10 years, where will valuations be then? We're positing that stock prices stay flat in real terms, and that dividends (earnings, for our purposes here?) also stay flat at about 2%. That means valuations (stock price/avg previous 10 years earnings) will also remain unchanged at their existing high levels. High valuations = continued low dividend yields and (according to the previous history) , no realistic expectation of significant price appreciation. If we want the flowers, we have to accept the rain. If we want higher dividend yield and (eventually) higher stock price growth, then the real price of equities needs to drop. That'll sting a bit.

It will depend on what earnings do.

It is feasible that earnings rise more than the 2% real stock market price returns + 2% dividend yield.

In that market case valuation falls.

There are times when earnings grow but stock prices do not. It could be a valuation "catch up" decade.

the earnings growth story forecast question has not been answered /addresses yet ... That's the other piece of the puzzle of course.

[samclem]

Quote:

Originally Posted by Options If you've done the hard work of having accumulated a sufficient PF, lowering your AA the 5 years before/after retirement, created an ISP with a plan B, C,, and possibly D, SOR shouldn't bother you. At that point, there's nothing you can do about a bad SOR at the start of retirement anyway. As Otar says, it's the "luck factor".

Right, but you've said a mouthful with those "if you've done" steps. There are some practical things (esp the need for spending flexibility ("cushion") and the very high utility of variable withdrawal amounts based on annual portfolio performance) that are essential for those considering retirement at high valuations to understand.

Quote:

Originally Posted by Gone4Good I'd like to dig into the analysis that yields this conclusion.

I didn't find the article lsbcal was citing on the M* site, but here's the reprint at Yahoo. No deep details there, however.

[Options]

Quote:

Originally Posted by audreyh1 Kitces is not actually predicting - he is talking about how different indicators have worked as past predictors. That is an entirely different message.

Quote:

Investors may not be rewarded for risk-taking during the next several years, so they should tweak their spending and saving patterns instead, says financial-planning expert Michael Kitces

Sounds like the usual, typical, hedged prediction to me. And tweaking one's spending patterns in response to market behavior is not at all new news.

Here's what Josh Brown has to say:

Nobody Knows Nothing, Episode 653

Quote:

Stop already. Strategists are interesting to read for context and to understand what other large pools of money and investors are thinking. Even the strategists themselves hate the fact that they have to play the target game. ... One of the benefits of having an investment process with diversification and a rules-based orientation is that you don’t end up chasing the guesses of others. Anyone’s guess is as good as anyone else’s in a world of almost infinite variability.

Emphasis added

[2017ish]

Quote:

Originally Posted by Gone4Good You're right, 1966 squeaks in at 24.06x. 10-year treasuries were at 4.6% then, though. ....

Interesting discussion...

I wondered about inflation when I saw the 4.6%. C.P.I. inflation rate in 1966 (December v. Dec. 1965) was 3.46% Inflation 1966 – Overview CPI inflation by country in 1966

Granted, the inflation measurement goal posts have moved over the years and I am not competent to attempt those adjustments, but taking it at face value, that would indicate a real yield of 1.14%. Still better than the present quote on 10 year TIPS (.53%), but closer than I would have thought.