I’ve posted Entry #258 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called It Is Critical to Distinguish Returns-Sequence Risk from Valuations Risk When Calculating Safe Withdrawal Rates.
Juicy Excerpt: Kitces makes a critical (and common) mistake, in my assessment. He fails to distinguish the risk that comes from retiring at a time of high valuations and the risk that comes from experiencing a poor returns sequence. He refers to the time-periods that produced the 4 percent rule as time-periods in which we saw poor returns sequences. But it was NOT the returns sequences that caused those retirement failures (for investors taking withdrawals of more than 4 percent).
Consider the retirees who retired at the top of the bubble that brought on the Great Depression. The returns experienced in the years following 1929 were poor. So there is a widespread inclination to say that those we retired in 1929 were “unlucky.” But this is not so!
What the data actually shows is that the returns sequence that we saw from 1929 forward was neither a lucky one nor a lucky one — it was an average returns sequence. The returns were poor. But that was because the valuation level that applied in 1929 was insanely high. Given the valuation level that applied in 1929, the returns experienced in the following years were about what you would expect. It is not possible to make an informed statement as to whether a particular return was a lucky one or an unlucky one without first taking into consideration the valuation level that applied at the beginning of the time-period under examination.