Your retirement may not be as badly damaged as you think.
Yes, I know that’s hard to believe. Whether you are 50 or 65, losing a third or more of your retirement savings puts a really dark cloud over your future. That’s what we’re being told, day in and day out, by the talking heads on TV.
Well, some historical evidence says they’re wrong.
They’re wrong because they aren’t considering the biggest factor that affects the amount of money you can safely withdraw from your retirement portfolio--- market valuation levels. Retire when market valuation levels, as measured by the price-to-earnings ratio for a stock, are high and you’ll be taking a big risk if you take more than 4 percent a year.
We can argue about what the exact P/E level of the current market is, but there is no doubt that it is down substantially. And below average. So if you were planning to make withdrawals at a 4 percent rate, you may now be able to make them at a 6 percent rate.
In other words, even though you may have lost one-third of your nest-egg, your retirement spending may suffer very little. Take 4 percent from a $300,000 nest egg and you’ve got $12,000 to spend. Take 6 percent from a $200,000 nest egg and you’ve got… $12,000 to spend.
You can understand how this works by checking the data from a research exercise I did using Morningstar Principia. The exercise is similar to what I did years ago (1995) when Peter Lynch suggested that people could be 100 percent invested in common stocks, withdraw 7 percent annually and never go broke. Using similar software, I showed that Mr. Lynch was wrong--- you had a substantial chance of running out of money at such high withdrawal rates, even though stocks averaged returns of 10 to 11 percent.
This time the test is to compare two 25-year investing periods. The idea is to see how many of a group of fourteen well-known mutual funds survived the period at different withdrawal rates. In both periods the funds were the same, a mixture of 14 load and no-load balanced and domestic large blend equity funds that have very long histories. Here’s the list: Alliance Bernstein Balanced A shares, American Funds American Balanced A shares, American Funds Investment Company of America A shares, Dodge and Cox Balanced, Dreyfus, Eaton Vance Balanced A shares, Fidelity, Fidelity Puritan, George Putnam of Boston A shares, MFS Massachusetts Investors Growth Stock A shares, Pioneer A shares, T. Rowe Price Balanced, Vanguard Wellington, and Vanguard Windsor.
In each time period the funds were set for initial withdrawal rates of 4.2 percent to 9.0 percent. Then the initial dollar withdrawal amount was increased each year by 4 percent to account for inflation. The program calculates the value of each fund at the end of each year. The results are shown below.
Down Is Up: Low Valuations Mean Higher Possible Withdrawal Rates
This table shows the number of funds from a sample of 14 that survive a 25 year retirement period at different withdrawal rates. It also shows that the number of surviving funds changes a great deal depending on whether you start making withdrawals in a period of high, or low, equity valuations.
|Initial percentage withdrawal rate>||4.2%||6.0%||6.6%||7.2%||8.1%||9.0%|
|High Valuation (11/01/68-10/31/93)||11||1||0||0||0||0|
|Low Valuation (11/01/83-10/31/08)||14||14||12||9||6||1|
|Source: Morningstar Principia|
Start at a period of high valuation--- such as the 25 years beginning in late 1968--- and 3 of the 14 funds don’t even survive a 4.2 percent withdrawal rate for the 25 year period. Raise the withdrawal rate to 6 percent and only one fund survives. All the others run out of money before the 25 years are up. Raise the withdrawal rate to 6.6 percent and not a single fund survives.
Start at a period of low valuation--- such as late 1983--- and retirement improves substantially: all fourteen funds survive 25 years of 6 percent withdrawals. You have to ratchet the withdrawal rate up to 9 percent before you whittle the funds surviving down to a single “last man standing” fund.
That’s quite a difference.
Is this a lead pipe cinch--- just raise your withdrawal rate to compensate for lower asset values? No, it’s not. But the odds are in your favor.
On the web:Morningstar Principia software
Earlier columns about Peter Lynch and dangerous withdrawal rates:October 1, 1995: Dangerous Advice from Peter Lynch
October 3, 1995: What a Difference a Year Makes
October 8, 1995: Making the Lynch All-Stock Strategy Work