Wade Pfau, Associate Professor of Economics at the National Graduate Institute for Policy Studies in Tokyo, Japan, yesterday posted to his blog words evidencing support for the idea of permitting honest posting on safe withdrawal rates. He made specific mention of the role played by Vanguard Founder John Bogle in helping the Retire Early and Indexing discussion-board communities become aware of the need to take valuations into consideration when identifying the safe withdrawal rate (it was by reading Bogle’s book Common Sense on Mutual Funds that I learned that the Old School safe withdrawal rate studies get the numbers wildly wrong).
Pfau’s article is called Can We Predict the Sustainable Withdrawal Rate for New Retirees? He states: “Retirees now frequently base their retirement decisions on the portfolio success rates found in research such as the Trinity study. Studies such as those are fine for what they accomplish: they show how successful different withdrawal rate strategies were in the historical data. But it must be clear that this is not the information that current and prospective retirees need for making their withdrawal rate decisions. John Bogle makes clear why in his 2009 book, Enough. Though he was speaking about stock returns, the same idea applies to sustainable withdrawal rates, since they are related to the returns of the underlying portfolio of stocks and bonds. He wrote, “My concern is that too many of us make the implicit assumption that stock market history repeats itself when we know, deep down, that the only valid prism through which to view the market’s future is the one that takes into account not history, but thesources of stock returns” (page 102, original emphasis).
The next paragraph of Pfau’s blog entry further explains that: “Future stock returns (and, therefore, future sustainable withdrawal rates) depend on the sources of returns: dividend income, growth of the underlying earnings, and changes in the valuation multiples placed on those earnings. The historical average success rate for a withdrawal strategy is not the information retirees need to know when determining their forward-looking sustainable withdrawal rate. As Mr. Bogle also writes, “But no, the contribution of dividend yields to returns depends, not on historic norms, but on the dividend yield that actually exists at the time of the projection of future returns. With the dividend yield at 2.3 percent in July 2008, of what use are historical statistics that reflect a dividend yield that averaged 5 percent – more than twice the present yield? (Answer: None.)” [the bolding in this passage appears in Pfau’s blog entry.]
I put a comment to the blog entry advancing the following words:
This is the most important paragraph ever written about retirement planning, Wade. You get it ALL in the paragraph quoted above:
1) You note the importance of the Old School SWR studies;
2) You make clear why we must make retirees and aspiring retirees aware that it would be dangerous to use one of the Old School studies to plan a retirement;
3) You focus in on Bogle’s important contribution (I learned that the Old School SWR studies are analytically invalid for purposes of identifying the safe withdrawal rate by reading Bogle’s book “Common Sense on Mutual Funds”); and
4) You explain WHY the Old School studies do not do the job for which tens of thousands of financial planners have employed them — because they do not look to the SOURCE of returns and there is no way to identify the safe withdrawal rate without doing so.
I will say a prayer that your new study will be the thing that will bring all the bickering we have seen in the Retire Early and Indexing discussion-board communities to a full and complete stop. We need healing and I believe that you have come up with the formulation that will finally help us achieve it.
Lots of people have made important contributions. That includes Bogle. That includes the authors of the Old School studies. That includes the thousands of our fellow community members who have expressed a desire that honest posting be permitted at every investing board and blog on the internet. That includes John Walter Russell. That includes you. I think it would be fair to say that that includes me.
You are a hero, Wade. I’m not joking about that. This is a delicate business. And it is a very, very important business. This investing study is an investing study that matters.
I look forward to talking these matters over with you soon at the Bogleheads Forum!