My blog entry for last Thursday reported on recent research by Michael Kitces, Director of Financial Planning at Pinnacle Advisory Group, Inc., showing quite properly that valuations affect safe withdrawal rates (SWRs) in an upward direction but failing to report that valuations affect SWRs in a downward direction as well. Set forth below is the text of an e-mail that I sent to Michael on Friday.
This is Rob Bennett. I am the founder of the Retire Early discussion-board community. We have been engaged in extensive examination of the flaws of the Old School Safe Withdrawal Rate (SWR) studies over the past six years. I saw your recent study on the effect of valuations on SWRs and thought that I should share some highlights of our findings with you.
I think you are absolutely right on in your finding that valuations affect SWRs. I view it as an important development in the field that you have made this point so effectively.
However, I do not think you are right to go along with the Old School claim that valuations do not in times of high valuations bring the SWR down below 4 percent. I am strongly persuaded that valuations can cause the SWR to go down as well as up. The research done by John Walter Russell shows that, at the top of the recent price bubble, the SWR for a high-stock-allocation portfolio was 1.6 percent. That means that there are likely going to be millions of busted retirements in days to come among the retirees who put their faith in the widely reported Old School claims.
Here is a link to a blog entry that I wrote on your study:
Here is a link to Russell’s web site (which contains his extensive SWR research):
Here is a link to The Retirement Risk Evaluator, the first analytically valid SWR calculator (at the bottom of this page, there are links to articles containing community comments about our findings and expert commentary on the issues at play):
Here is a link to a podcast (Podcast #5) that I recently recorded providing an overview of The Great Safe Withdrawal Rate Debate held at the Retire Early and Indexing discussion-board communities:
I view the SWR topic as being of great importance. When you calculate the SWR improperly (as do those following the Passive Investing model for understanding how stock investing works), you get all sorts of other things wrong as well. When you calculate the SWR properly, it opens your eyes to all sorts of things that you thought you understood but that you in reality did not understand well at all. The most compelling illustration of this is the way in which our coming to terms with the SWR concept helped us to understand how to go about making effective “predictions” of long-term stock returns starting from various valuation levels through use of a regression analysis applied to the historical stock-return data:
I much enjoy exploring this stuff ever deeper. If you have questions or comments, please shoot me back an e-mail.
Thanks for your efforts in getting the message out that valuations need to be taken into account in retirement planning. It’s been a long, hard road getting some people to accept this terribly important and painfully obvious reality!