“The Fact That 4 Percent Barely Survived Is Not Telling You That a 4 Percent Withdrawal Is “100 Percent Safe.” It Is Telling You That It Is High Risk.”

Set forth below is the text of a comment that I recently posted to the discussion thread for another blog entry at this site:

Nothing is certain, we’re all working on probabilities. What are the odds an asteroid destroys the world as we know it and ruins my retirement plans?

The amount of irrational exuberance present in the stock price at a given time greatly influence the probability that investors will see poor outcomes. If valuations affect long-term returns, then valuations affect risk. The safe withdrawal rate is a risk-assessment tool. So it is a logical impossibility that the safe withdrawal rates is the same number at all valuation levels.

Asteroid hits are unlikely events, Price crashes at times when valuations are at insanely dangerous levels are common events. The CAPE was 33 in 1929, when a 30-year retirement plan with a 4 Percent withdrawal barely survived. In ordinary circumstances, a 4 Percent withdrawal would permit huge gains in portfolio value over 30 years. Why did a 4 percent withdrawal barely survive? Because valuations were so insane at the beginning of that retirement.

The fact that 4 percent barely survived is not telling you that a 4 percent withdrawal is “100 percent safe.” It is telling you that it is high risk. Try it again and it might well fail. Try it at a time of moderate valuations and you will see your portfolio value skyrocket. But try it again at a time of insane valuations and it might well fail. Valuations are by far the most important factor in assessing retirement safety. So it is not possible to assess retirement safety reasonably without taking valuations into consideration. You need to give some consideration to the most important factor.

Rob