Bear Market Isn’t a Disaster for Retirees

[Htown Harry]

"Bear Market Isn’t a Disaster for Retirees" is the title of Scott Burns' column today. Bear Market Isn’t a Disaster for Retirees - Registered Investment Advisor

In a nutshell, he says research shows that SWR's can safely go up a percentage point or so when the market is down:

"If prospective returns are higher in low valuation markets, perhaps retirees can safely increase their withdrawal rates. Research by financial planner Michael Kitces has shown that the usual 4 percent rule of thumb for initial withdrawal rates from retirement nest eggs can be increased in periods of low valuation. A typical 60/40 (equity/fixed income) portfolio, for instance, will only support a safe withdrawal rate of 4.4 percent in a high valuation market. But it will safely sustain a 5.7 percent withdrawal rate in a low valuation market..."
​

The link to Mr. Kitces' report is broken, but I understand the gist of it: Retire at the peak of the market and he calculates the SWR rate will be less than if you retire at a time that the market is at a low.

Said another way, a reversion to the mean rate of stock market returns can cut both ways, tending toward hurting the returns of the retire-at the-peak folks and helping those who start withdrawing at a time of market lows.

I take Mr. Burns with a grain of salt, so it's not likely that I'll jump on this particular bandwagon. But I do have a question.

Supposing one did buy into this idea, how would one know today's market's relative value? Burns gives no specific support for his statement that today's market is in the "third decile" of valuation.

Would traditional measures like the S&P 500's P/E or dividend rate be a sufficient indicator of the market's valuation? Or would it be some sort of technical indicator? The amount of government financial bailouts being doled out in a particular year?

 

[DblDoc]

Kitces used the P/E10. I don't know what it is currently but I suspect it is still pretty high. I have seen some quoting "low P/E's" but that is based on todays price divided by last years earnings...

DD

 

[CuppaJoe]

Here's a recent similar thread about a Scott Burns article:

http://www.early-retirement.org/forums/f28/the-6-swr-its-official-41070.html

 

[OAG]

Sort of what I have felt for some time. Seems to me if one starts taking a 4% SWR (which is adjusted up for CPI numbers each year) after about 10 years of ER you would be someplace between 5-6% anyway (of the basis of the initial withdrawal). Of course the older one gets the years to the "top number" (life expectancy) becomes lower. At some point it becomes "expected" years to go divided into the "nest egg" which will govern the a "higher" SWR (assuming the need to leave a "pile" behind is not a consideration). Helps to have a finite "nest egg" too.

 

[W2R]

I wonder if we aren't moving into "uncharted territory", so to speak, with the recent economic crisis. Whether we choose 4% or 5.7%, we may want to polish up our LBYM and belt-tightening skills just in case such withdrawal rates don't turn out to be feasible for us in the long run.

Or am I unduly worried and stressed out over this economy? I'm determined to retire anyway.

 

[Dawg52]

I wonder if we aren't moving into "uncharted territory", so to speak, with the recent economic crisis. Whether we choose 4% or 5.7%, we may want to polish up our LBYM and belt-tightening skills just in case such withdrawal rates don't turn out to be feasible for us in the long run.

Or am I unduly worried and stressed out over this economy? I'm determined to retire anyway.

No. I'm just thankful I can live fine on 3% of my battered portfolio.

 

[ziggy29]

The link to Mr. Kitces' report is broken, but I understand the gist of it: Retire at the peak of the market and he calculates the SWR rate will be less than if you retire at a time that the market is at a low.

Said another way, a reversion to the mean rate of stock market returns can cut both ways, tending toward hurting the returns of the retire-at the-peak folks and helping those who start withdrawing at a time of market lows.

I think this is intuitively obvious -- but translating that into a reliable mechanical strategy that doesn't reek of data mining is a bit more problematic.

 

[W2R]

No. I'm just thankful I can live fine on 3% of my battered portfolio.

Me, too. I'd really be worried if I felt I needed 5.7% just to make ends meet.

 

[Moemg]

I'm just wondering how many of our retired members are still using the 4% plus inflation from their orginal portfolio when they retired ? I don't have the guts for that so I just do 4% of my portfolio on Jan.1 each year .

 

[ziggy29]

I'm just wondering how many of our retired members are still using the 4% plus inflation from their orginal portfolio when they retired ? I don't have the guts for that so I just do 4% of my portfolio on Jan.1 each year .

I don't think I'll have the guts to use 4% now.

While this economy is still nowhere near that of the 1930s and hopefully it never will be, I have a newfound appreciation for the money mentality of so many of the people who lived through those times.

 

[RonBoyd]

 

[Architect]

What reversion to the mean is he talking about? The S&P has actually been above long term trend for a decade or more.

S&P Regression to Trend | The Big Picture

 

[ziggy29]

What reversion to the mean is he talking about? The S&P has actually been above long term trend for a decade or more.

S&P Regression to Trend | The Big Picture

How do they go back to 1871 when the S&P 500 has only existed since 1957? Even the Dow only goes back to the 1890s, IIRC.

 

[Architect]

Looks like he's using the Shiller data -

dshort.com - Financial Life Cycle Planning

I haven't checked what Shiller bases his on. I think it's used in FIRECalc though, for instance.

 

[FIRE'd@51]

IMO, the optimal retirement would occur if you had sufficient assets to live off the dividend income from the S&P 500, since over the long-term dividend growth has outpaced inflation. This will likely be the case in the future. Unfortunately, most of us do not have enough assets to do this, so we shoot for the 4% (25 times) SWR.

Imagine you had enough assets to live off the S&P 500 dividend, which currently equates to about a 3% yield. You would likely have a perpetuity SWR of 3%. If the S&P 500 were to drop another 50% without further dividend cuts, this number would be 6%.

I think most of us are comfortable living off the income thrown off by our portfolios, and adjusting our withdrawal rates to that income. The problem is not the portfolio value so much as the income thrown off. In 2008, the Vanguard S&P 500 index fund paid the same annual dividend as in 2007, even though the index price was down 38.5%.

Obviously, for someone who's income came predominantly from bank stocks, this wouldn't apply, since there have been massive dividend cuts in banks. However, someone who is living off a well-diversified portfolio of dividend payers (e.g. the S&P 500) can have a significantly higher SWR in a bear-market than Firecalc might suggest, with plenty of safety, and should never have to sell assets when the price is down, which is the cause of a Firecalc failure.

So, to those of you who are feeling discouraged that you won't be able to FIRE anytime soon, I would say that today you would likely be 100% safe in perpetuity with a portfolio of 33 times your SWR, where as at the market high in 2007 you would have needed a portfolio 60 times your SWR. So, if your required withdrawal amount is 60K, a portfolio of $2MM will do it today, whereas back at the market high of 2007, you would have needed $3.6MM. To the extent that your portfolio has outperformed the S&P 500 in 2008, you have actually gained on FIREing.

 

[ziggy29]

Looks like he's using the Shiller data -

dshort.com - Financial Life Cycle Planning

I haven't checked what Shiller bases his on. I think it's used in FIRECalc though, for instance.

Wouldn't surprise me, since it's not unusual to trace back to 1871 (or 1926). But it still seems misleading to call it the S&P.

Anyway, I think you can't really look too much at current valuation relative to the long-term trend line without other considerations such as current interest rates. A stock market valuation which may be cheap given today's interest rates (3% long Treasuries) would be overvalued with the interest rates of 1981 (12% long Treasuries).

 

[Ed_The_Gypsy]

RE: FIRE'd's comments, I have noticed that my earnings are more stable than valuations. A lot more stable. I am looking at planning based on my earnings stream rather than a rigid percentage. I am reminded of the old joke about the Boston matrons who resorted to prostitution rather than spending their capital.

 

[W2R]

RE: FIRE'd's comments, I have noticed that my earnings are more stable than valuations. A lot more stable. I am looking at planning based on my earnings stream rather than a rigid percentage. I am reminded of the old joke about the Boston matrons who resorted to prostitution rather than spending their capital.

How do we know that earnings will remain relatively stable? It seems like we are navigating uncharted waters these days. Sorry if the question is stupid but I really don't know the answer. So, I have even considered living on less than my earnings and plowing the rest back into principal (at least for a couple of years until I get my feet wet once I become a new ER).

I'm not from New England, but my now deceased parents really drummed into me the idea of not touching one's principal.

 

[haha]

I'm not from New England, but my now deceased parents really drummed into me the idea of not touching one's principal.

Mine did too. In fact, they drummed into me the idea of not touching one's anything.

Ha

 

[TromboneAl]

We can't help spending less than our 4% + Inflation allowance each year, due to the current market conditions, but my spreadsheet keeps track of the how much less. That amount goes in to the fun money column, to be spent in better times.

 

[W2R]

Mine did too. In fact, they drummed into me the idea of not touching one's anything.

Ha

That too.

 

[CuppaJoe]

We can't help spending less than our 4% + Inflation allowance each year, due to the current market conditions, but my spreadsheet keeps track of the how much less. That amount goes in to the fun money column, to be spent in better times.

I retired in Sept. '08 but added the inflation rate to the 4% amount for '09. I expect a tax refund which will be about a month and a half PF withdrawal. I'll keep that amount and some other odd additions and savings as an emergency fund.

 

[Bikerdude]

I retired in 2000 and began a 4% WD rate. With the recent market downturn I am at 6% WD. Beginning next year I will collect SS and my WD rate will drop to 3.5% if my balance stays the same.

Going forward, I estimate I'll be around for another 25 years max, so if the market rebounds, I will have no problem taking a 5% WD in good years.

 

[cjking]

The logic that the percentage should be adjusted with valuations is correct, but the idea that shares are currently cheap is wrong.

4% is the rate for someone who retires in an average year. Starting in the early nineties and ending last year, shares have been overvalued, so a valuation-adjusted rate for people retiring during that period would have been less than 4%. We are back at average valuations now, so 4% (not more) is the right figure now.

 

[ziggy29]

The logic that the percentage should be adjusted with valuations is correct, but the idea that shares are currently cheap is wrong.

Depends on how you value the market.

Relative to historical levels, the 100-year trend line and some P/E measures, stocks are roughly at "fair value," down from "horrifically overvalued" 9 years ago.

But relative to current interest rates, stocks are very cheap. A 6% earnings yield looks a lot cheaper with 3% Treasuries than with 8% Treasuries.

In reality, anyone can cherrypick their favorite metric to make valuations look either insanely cheap or wickedly overvalued.