As readers of my newsletter know, in May I published research that challenges the safe withdrawal rate as potentially being TOO safe in some environments, where market valuation is not at unfavorable extremes. However, in some feedback I’ve received from readers, another important point is being made – in some cases, the safe withdrawal rate may also still be too aggressive!
In a compelling blog entry, Rob Bennett of PassionSaving.com makes a good point – that while my research accounts for valuations in one direction, maybe we still haven’t given enough weight and attention to what happens when valuations move to the MOST significantly unfavorable extremes.
As my research noted, all of the least favorable "safe" withdrawal rates occur, not surprisingly, when market valuation is unfavorable. However, there’s perhaps a difference between unfavorable valuations, and UNFAVORABLE valuations.
For instance, the valuations at the start of the current decade reached extremes far beyond anything we have ever seen in history. Which begs the question – if high market valuations compress returns and thereby compress safe withdrawal rates, is it possible that the record high valuations from year 2000 could produce new record low safe withdrawal rates?
Offhand, I have to admit that I think this is a genuine possibility. To the extent that high valuations compress returns and interest rates, it is certainly reasonable to expect that the record valuations of 2000 will produce record-low long-term returns in the decades that follow – which in turn, could produce new record-low safe withdrawal rates. In point of fact, research by John Walter Russell implies that a safe withdrawal rate from year-2000-level valuations could be under 2%!
It’s worth noting that Russell’s work is still only hypothetical, although there is a fascinating retirement calculator based on his work that projects the safe withdrawal rate in any particular valuation environment. It remains true that the worst safe withdrawal rate period we’ve ever ACTUALLY seen ran from 1966 to 1995, and produced our traditional "4%" rule for safe withdrawal rates. Will 2000-2029 ultimately produce a worse result? Yes, it’s quite possible, and even likely, given the incredibly distorted valuations, but only time will tell.
So what should we do from here? Well, the "good" news is that today’s valuations are no longer anywhere near the year 2000 extremes. Instead, we’re merely in the "high" valuation environment that produced the kind of 4% safe withdrawal rates we’ve seen at similar high valuation points in history – which means we should be comfortable with the 4% safe withdrawal rates being applied today.
On the other hand, for those who already retired at the start of the decade following the 4% rule, it may be time to sit down and update the plan, and face some hard facts given that the portfolio will almost assuredly be underperforming any original projections at this point. If Russell’s projections of a sub-2% withdrawal rate prove to be true, or are anywhere close, those who retired back in 2000 may ultimately find that the "4% safe withdrawal rate" was still far too aggressive, making the point once again about how critical it is to incorporate market valuation into retirement projections!