Wade Pfau looks at 4% WR, finds it unsafe

[MichaelB]

Wade Pfau's latest blog update is here Reality Check on Retirement Planning Assumptions. He has developed a forecast for asset class returns, tested the 4% withdrawal rate, and finds that with a allocation of 50% equities it fails 47% of the time.

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[ejman]

I certainly hope the assumptions are too pessimistic. Beyond the early retiree 4% impact, long term returns like that would also doom many defined benefit plans and force fixed annuity sellers into bankruptcy.

 

[Chuckanut]

The end of a 4% SWR?

Here is an interesting comment from Wade Pfau. As I read this, Dr. Pfau is now strongly leaning towards a future where the 4% withdrawal rate will have a much higher failure rate than we previously thought - close to 50%. Some food for thought....

Retirement Researcher Blog: Reality Check on Retirement Planning Assumptions

 

[MichaelB]

merging threads

 

[Nords]

Wade Pfau's latest blog update is here Reality Check on Retirement Planning Assumptions. He has developed a forecast for asset class returns, tested the 4% withdrawal rate, and finds that with a allocation of 50% equities it fails 47% of the time.

To be fair to his other posts, he advocates annuitizing a "floor" retirement income and using a variable withdrawal scheme. This analysis also ignores Social Security.

He's not proclaiming the end of retirement. He's pointing out that the 4% SWR could be an artifact of the 20th century. Hopefully it becomes one of the 21st century, too...

 

[Lsbcal]

Wade Pfau's latest blog update is here Reality Check on Retirement Planning Assumptions. He has developed a forecast for asset class returns, tested the 4% withdrawal rate, and finds that with a allocation of 50% equities it fails 47% of the time.​

What I did not see in that article is the time element Phau is assuming. Does he really mean to assume a real return (CAGR) of only 3.1%/0.1% for stocks/bonds over perhaps the next 20 years? It is true that 20 year TIPS are currently at 0.2% but should we expect that to prevail over the next 20 years or will it fluctuate just as violently as that rate has over the past decade?

Examining the assumptions behind the curves is really crictical as the rest is pretty much mechanical. Over the last decade Pfau's assumptions would have violently changed. I think those current assumptions are just recency bias.
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[Midpack]

To be fair to his other posts, he advocates annuitizing a "floor" retirement income and using a variable withdrawal scheme. This analysis also ignores Social Security.

I've seen him mention his preference for floor income before withdrawals and other approaches several times, but I've yet to find a paper or post of his devoted to the subject itself. Have you seen one?

He seems to advocate floor income, buying it if you have to, as Plan A. (my euphemistic way of agreeing with W2R's post below). I'm still viewing additional floor income, over the admittedly inadequate Soc Sec, as part of our Plan B - knowing I can buy in whenever I want to.

I guess it all comes down to what one's outlook for our future years is. Is this just another recession (albeit an unusually bad one) from which we'll recover and have wonderful expansions (and recessions) --- or --- has the world and the USA's place in it been irreversibly changed. Like many others, I can find convincing cases for either. Good question...I just haven't given up on the USA just yet.

 

[W2R]

I do not find his results to be surprising, although I also do not know if they are correct (and as others have pointed out more tactfully, he sometimes seems more like an annuity salesman than anything else).

Still, I think many of us remember the days when "common knowledge" seemed to be that a 6% or even higher SWR would be sustainable in retirement. The percentage has been drifting lower ever since. I really didn't expect that downward drift to reverse while experiencing global economic troubles in the past few years.

At some point, one has to draw a line in the sand and say "this is it for me".

 

[Chuckanut]

I guess it all comes down to what one's outlook for our future years is. Is this just another recession (albeit an unusually bad one) from which we'll recover and have wonderful expansions (and recessions) --- or --- has the world and the USA's place in it been irreversibly changed. Like many others, I can find convincing cases for either. Good question...I just haven't given up on the USA just yet.

There will always be reasons for doom and gloom. The astute investor will take well calculated risks at times which should be rewarded. I do not recommend a "damn the torpedos, full speed ahead" approach, but, as mentioned before, John Templeton made a fortune buying stocks that sold for under $1 a share in 1939 when the world was still in a recession and WW2 was looming. He made money on the vast majority of them.

Note1: This is my idea of a calculated risk: One takes this much risk for this much gain .

Note 2: A foolish risk is this: One takes this much risk for this much gain .

Oh, never bet the farm.

My 2 cents.

 

[Meadbh]

I think those current assumptions are just recency bias.

I certainly hope that's true, but so much has changed that it would be wishful thinking to assume that historical returns will be the norm in the 21st century. I prefer to think conservatively and calculate on the basis of ~3% SWR.

 

[Nords]

I've seen him mention his preference for floor income before withdrawals and other approaches several times, but I've yet to find a paper or post of his devoted to the subject itself. Have you seen one?

I think he's still working on it, although he seems to be experimenting with some simulations.
Retirement Researcher Blog: The Power of Single-Premium Immediate Annuities
Retirement Researcher Blog: Reader question about annuities (SPIAs)
Retirement Researcher Blog: Choosing a Retirement Income Strategy

 

[clifp]

To be fair to his other posts, he advocates annuitizing a "floor" retirement income and using a variable withdrawal scheme. This analysis also ignores Social Security.

He's not proclaiming the end of retirement. He's pointing out that the 4% SWR could be an artifact of the 20th century. Hopefully it becomes one of the 21st century, too...

While it is true that he advocate annuitizing for a floor, he seems to be glossing over a pretty simple fact. How the heck do the insurance companies or pension funds pay our annuity if returns are so lousy across asset classes? For that matter if returns on capital are this bad this also implies a stagnant GDP growth, and that begs the question how is Uncle Sam going to get the money to pay its social security and pension obligations?

As a commenter on his blog put it.

I am retired at 50 yo. My withdrawal rate is about 1% of investable assets which represents about 70% of my net worth. My investment portfolio is about 50/50, passively invested with the bond portion being 100% munis. 100% taxable account. I have no debt. One line of reasoning that I keep returning to is that if I can't make it on 1%, what's going to happen to everyone else? pension funds? 401k's? I think we would be looking at a breakdown of society at that point.

The forum as a whole is much closer to the 1% in terms of wealth (if not necessarily income and certainly not spending) than the 99%. So if we are worried that 4% or 3% and even 1% isn't achievable what hope does the rest of the country/world have?

Personally I think the future global economic prospects are considerably brighter than current returns on capital indicate. A billion consumers who a decade ago were living on subsistence agriculture in China, India, Brazil etc. now want, need and most important can buy goods and services. While the superior return of US equities of the 20th century may not be repeated, I also don't see repeat of two world wars, or a awful system like communism taking over 1/3 of the world and dragging down international equity returns.

For the intermediate term we are in a period of adjustment which will be hard for many living in western countries. But in the long term I see no reason that 2-2.5% productivity and .5%-1% population increase won't result in real returns of 3% add to that spending down corpus a bit as you age and 4% still seems achievable.

 

[Nords]

... and that begs the question how is Uncle Sam going to get the money to pay its social security and pension obligations?

Well, insurance companies don't have the legal right to raise taxes and print money.

I guess the short answer to that question is "Confiscation!"

For the intermediate term we are in a period of adjustment which will be hard for many living in western countries. But in the long term I see no reason that 2-2.5% productivity and .5%-1% population increase won't result in real returns of 3% add to that spending down corpus a bit as you age and 4% still seems achievable.

I agree with you. Such low investing returns for the rest of our life seem impossible. Maybe in 19th century Britain, when inflation was nearly zero percent for the whole century, but not today.

Pfau's done a lot of tood work to rectify the mutually opposed goals of "4% SWR" with "zero failure". The Trinity Study got to 4% without variable spending and Social Security, let alone annuities, so I think there's some wiggle room.

Of course people who want to be absolutely, positively sure then they could work until they can find a "safe dividend rate" that exceeds their expenses. Personally I'd rather lay off a little longevity risk to an insurance company in exchange for 5-10 fewer years of paychecks.

 

[Animorph]

I agree with you. Such low investing returns for the rest of our life seem impossible. Maybe in 19th century Britain, when inflation was nearly zero percent for the whole century, but not today.

We are sort of following Japan's path into stagnation, not that I think we would do it that badly, I hope. One of the reasons I'm only about 50% U.S. equities.

While it is true that he advocate annuitizing for a floor, he seems to be glossing over a pretty simple fact. How the heck do the insurance companies or pension funds pay our annuity if returns are so lousy across asset classes?

Annuities can show some apparent return just from life expectancies if you live long enough, even if the insurance company gives you 0% investment gain. Works fine for an ideal annuity. May be a little slim when fees are added. He looks at it more as insurance than an investment anyway.

 

[clifp]

We are sort of following Japan's path into stagnation, not that I think we would do it that badly, I hope. One of the reasons I'm only about 50% U.S. equities.



Annuities can show some apparent return just from life expectancies if you live long enough, even if the insurance company gives you 0% investment gain. Works fine for an ideal annuity. May be a little slim when fees are added. He looks at it more as insurance than an investment anyway.

Speaking of Japan. One of things that I wish Wade would do is study/report the impact the last 20 to 30 years have been like for Japanese retiree. If Japan is indeed the model of what we can expect for next 20+ year here in the US it sure would be helpful to know what worked and didn't work for a Japanese retiree circa 1985 and 1990.

At this point my preferred annuity provider is to delay SS till age 70. A close 2nd is change my personality and do more drinking, partying, dating strippers, and make sure I don't live much past 75.

 

[Spanky]

This article suggests that U.S. will most likely not follow the path of long period of economic stagnation faced by the Janpanese because of U.S. workforce growth and sound fiscal policies (by the U.S. government).
Japan's "lost decades" -- and economic stagflation in the U.S. | Harvard Magazine Jul-Aug 2010

 

[Nords]

We are sort of following Japan's path into stagnation, not that I think we would do it that badly, I hope. One of the reasons I'm only about 50% U.S. equities.

I don't agree with the U.S.=Japan comparison. There are a number of fundamental differences in the banking systems, the savings/investment architecture, the laws, and the demographics.

The reason Britain had negligible inflation during the 19th century was the gold standard, and the fact that they had optimized their global empire to manage the price of gold.

If there was a comparison with Japan, Wade would be all over it. That's where he lives & teaches, and I bet he's forgotten more about the comparative economics of our two countries than I'll ever learn.

About your 50% U.S. equities asset allocation: how many of those equities are shares of large multinational corporations with substantial earnings & assets from overseas business? I wonder what percentage of the S&P500 annual earnings comes from outside of the U.S.

 

[Katsmeow]

His follow up in the comment section is interesting (and refers to this thread in this forum actually). In part he says:

For a quick starter, do note that the assumptions here don't necessarily have to define the entire 30 year retirement period. With sequence of returns risk what happens in the early part of retirement matters a great deal more than what happens later on. Even if conditions "normalize" to the historical averages in 15 or 20 years, that will provide only a quite small amount of help to those retiring today. Wealth depletion in the mean time will be hard to overcome. It is like the worst-case scenario retiree from history: the 1966 retiree. The last half of this 30-year retirement was the 1980s and 1990s bull market, but by then it was too late, too much wealth was depleted to enjoy the recovery.

 

[marko]

I'm not even close to being a statistician (or mathematician) but can anyone comment on how Pfau's chart jibes with Firecalc's results?

At the same time, the bottom two curves flatten out around a 50% SA, suggesting a needless risk/reward. Counterintuitive?

 

[REWahoo]

I'm not even close to being a statistician (or mathematician) but can anyone comment on how Pfau's chart jibes with Firecalc's results?

Pfau's results are dramatically more pessimistic than FIRECalc. You would expect a 4% FIRECalc run to have a 95% chance of success vs. Pfau's 53%.

A comment on this from Pfau:

For a quick starter, do note that the assumptions here don't necessarily have to define the entire 30 year retirement period. With sequence of returns risk what happens in the early part of retirement matters a great deal more than what happens later on. Even if conditions "normalize" to the historical averages in 15 or 20 years, that will provide only a quite small amount of help to those retiring today. Wealth depletion in the mean time will be hard to overcome. It is like the worst-case scenario retiree from history: the 1966 retiree. The last half of this 30-year retirement was the 1980s and 1990s bull market, but by then it was too late, too much wealth was depleted to enjoy the recovery.

A bad sequence of returns early in retirement gives a similar high probability of failure in FIRECalc. Pfau's calculation essentially takes a bad initial sequence and continues it for 30 years.

I'm curious why he didn't include an asteroid strike to add a little levity...

 

[audreyh1]

I'm still trying to get my mind around the 0.3% real return on intermediate bonds. I guess it's because they are using govt bonds rather than a broader bond portfolio. And of course we know that Monte Carlo analysis gives the worst case.

Anyway - sure makes one want to pull in and reduce withdrawal away rates, doesn't it? I hadn't considered trying to drop down to 2.5% or something. I guess I'll keep with my 3.33% until we go to hell in a hand basket, then I'll be out bartering with everyone else....

This is all just getting way too sobering!

 

[jebmke]

I'm still trying to get my mind around the 0.3% real return on intermediate bonds. I guess it's because they are using govt bonds rather than a broader bond portfolio. And of course we know that Monte Carlo analysis gives the worst case.

Anyway - sure makes one want to pull in and reduce withdrawal away rates, doesn't it? I hadn't considered trying to drop down to 2.5% or something. I guess I'll keep with my 3.33% until we go to hell in a hand basket, then I'll be out bartering with everyone else....

This is all just getting way too sobering!

I think intermediate gov bonds have negative real yield. The .3% for a broad portfolio doesn't seem off the mark to me.

 

[audreyh1]

I think intermediate gov bonds have negative real yield. The .3% for a broad portfolio doesn't seem off the mark to me.

My point is - given that scenario, don't exclusively use government bonds! Use a diversified intermediate bond portfolio instead.

 

[ronin]

Using my actual returns for the past 120 months, my portfolio 70/30 portfolio earned 9.4% with a SD of 12.9%. Plugging that into my MC sim using a 30 yr withdrawal at 4%, I get a 93% success rate. At 35 yrs it drops to 90%, there'd be only a 10% probability of one of the 2 of us surviving, so the failure rate is now actually more like 1%.

Now who's crystal ball is better? Seems like it's pretty useful for entertainment value at best.

 

[Chuckanut]

It's not all doom and gloom. As I read the graph in Michael's post, the 3% withdrawal rate still offers a success rate in excess of 80%. Given the uncertainties of the future, that is not bad.