Michael Kitces recently published a study of safe withdrawal rates (SWRs) that adopts a mix of the Old School and New School approaches. Michael pointed out correctly that the SWR for a high-stock portfolio can go a good bit higher than 4 percent at times of low valuations (Yes! Yes! Yes!) but failed to point out that the SWR for a high-stock portfolio can also go a good bit lower than 4 percent at times of high valuations (Boo, Baby!). I wrote a blog entry on the first Nold School study and sent an e-mail to Michael applauding him for his big advance while pointing out that failing to go totally New School leaves millions of retirees at a big risk of suffering busted retirements in days to come.

Michael has given me permission to set forth the texts of his e-mails at this blog for the benefit of those interested in learning more about how SWRs work and how valuations affect long-term stock returns in general. This blog entry and a number of future ones will contain the texts of the e-mails that Michael and I sent to each other as we talked over the findings of the Retire Early and Indexing communities during the first six years of The Great Safe Withdrawal Rate Debate. Set forth below are the words of the e-mail that Michael sent my way on Monday, August 18.

Rob,

Thanks so much for getting in touch with me and passing this along! What a
great collection of material you have on your website!

Regarding your comments about the possibility that the SWR could be below
4%… well, I certainly wouldn’t say that I am in any way adamant that the
SWR could never be lower. To the contrary, I am a strong believer in the
long-term impact of valuation on market returns, and am well aware of the
impact that unusually high distorted valuations can have. In point of fact,
I still anticipate that ultimately, we will look back in another 25 years
and see that the time period from 2000-2029 will be the “new” worst case
scenario for SWRs, trumping even the damage of the 1966-1995 period.
Particularly if inflation continues to be as problematic as it has lately
become. However, we don’t yet have data to firmly establish that. At this
point, it’s reasoned speculation (albeit pretty well-reasoned) but not
necessarily a lot more, since we just don’t yet have the data to see how
this will ultimately play out.

That aside, given that today’s P/E10 ratios are more reasonably within the
range of other historical valuation peaks (not including the start of this
decade), I find that continuing to apply the 4% SWR methodology in today’s
environment to be reasonable. If we truly went back to P/E10 peaks earlier
this decade – valuations far beyond any point in the historical range – I
think I would agree with you that, to say the least, we need to HEAVILY
caveat any use of a 4% withdrawal rate. But today’s P/E10 is not in the 30s
or 40s. It’s back in the low 20s – damaging by any historical measure, but
not necessarily a valuation environment that will destroy a 4% SWR. Even
your own Retirement Calculator implies safe withdrawal rates around 4% at
P/E10 ratios around 21-22 (P/E10 22, TIPS 2.0, Stocks 40%, shows 4.00% SWR
on your site).

In point of fact, though, I did mean to make the exact point that you are
articulating more directly in my own newsletter – that ultimately, our 4%
SWRs are predicated on a certain range of valuations, and that to the extent
we have valuations that dramatically exceed that range (a la P/E10 in 2000),
we may find that the 4% SWR is invalidated at those levels. In retrospect, I
don’t think I made it as directly as perhaps I had wished, and I can
appreciate you calling me out on this.

But my focus in the newsletter was simply to put forth what we can at least
see in the existing historical record about the impact of a range of
valuations (and generally integrating valuation with SWRs) – a body of
research that I found to be lacking (although I’ll grant that’s partially
because the planning community seems to be generally unaware of your
passionsaving.com website!). To look at how the valuations earlier in the
decade may theoretically extrapolate in the future is absolutely worthwhile
– I just think it’s a separate (albeit related) extension of this research
path (and I only have so much room in any one issue of my newsletter!).
Nonetheless, this is still something I hope to explore further in the future
though!

In any event, the point here was simply to acknowledge that there ARE
valuation environments where higher SWRs appear to be “safe” (where
valuations themselves are more reasonable), but likewise to make the point
that today’s environment IS NOT ONE OF THEM. However, I also don’t find
today’s environment to be so valuation-stretched to imply that the 4% SWR of
the historical record is invalid – to the contrary, it appears to fall right
into the same category (as even your calculator indicates). Thus, the
conclusions of my research and how I stated it (which I’ll grant wasn’t
quite how BusinessWeek presented it, but you can’t always control how the
media portrays your research!). Could we get back to ultra-high valuations
again? Perhaps, although frankly I find it highly unlikely anytime in the
foreseeable future; the historical record also clearly shows that once
valuations start trending off of a peak, they ultimately dip below the
median and close to a historical low before another secular bull market
starts, so I find that a P/E10 of 12 is more likely sometime in the coming
decade than returning to a P/E10 over 30.

In any event, thanks again for sharing your website, your thoughts, and your
feedback. I will try to blog about your website myself and see if we can
make the planning community more aware of the great work that you’re doing.
And please don’t hesitate to contact me if I can otherwise be of service in
the future!

With much thanks and warm regards,

Michael