Not There Yet, Today

Prices are falling. Before long, we can expect P/E10 to fall to 20. Can we withdraw 6% (plus inflation)?

No. We are not there yet. Not using a traditional approach.

The Traditional Approach

The traditional approach used in Safe Withdrawal Rate studies sells stock shares as necessary with a stock/bond (S&P500/TIPS) portfolio. You vary withdrawals to match inflation. The withdrawal rate is the original amount withdrawn divided by the original portfolio balance.

Year 30 SWR Retirement Risk Evaluator

I set P/E10=20, TIPS interest rate=1.0% and the Year 30 final amount of 0%. These are the results:

Safe Withdrawal Rate
20% stocks with rebalancing: 3.74%.
50% stocks with rebalancing: 3.97%.
80% stocks with rebalancing: 3.99%.
Switch Option B: 4.37%.

Likely Success Rate (50%-50%)
20% stocks with rebalancing: 4.14%.
50% stocks with rebalancing: 4.67%.
80% stocks with rebalancing: 4.99%.
Switch Option B: 5.17%.

Almost Certain Failure Rate
20% stocks with rebalancing: 4.74%.
50% stocks with rebalancing: 5.57%.
80% stocks with rebalancing: 6.79%.
Switch Option B: 6.17%.

This shows that a 6% (plus inflation) withdrawal rate is likely to fail in today’s market.

I set P/E10=10, TIPS interest rate=1.0% and the Year 30 final amount of 0%. These are the results:

Safe Withdrawal Rate
20% stocks with rebalancing: 4.48%.
50% stocks with rebalancing: 5.95%.
80% stocks with rebalancing: 7.43%.
Switch Option B: 6.09%.

Likely Success Rate (50%-50%)
20% stocks with rebalancing: 4.88%.
50% stocks with rebalancing: 6.65%.
80% stocks with rebalancing: 8.43%.
Switch Option B: 6.89%.

Almost Certain Failure Rate
20% stocks with rebalancing: 5.48%.
50% stocks with rebalancing: 7.55%.
80% stocks with rebalancing: 10.23%
Switch Option B: 7.89%.

This shows that a 6% (plus inflation) withdrawal rate can succeed. The key is low prices (and 50% or more in stocks).

Scenario Surfer Runs

I invested entirely in stocks and TIPS. I started with a $100000 balance. I chose the P/E10=20 Bear Market. I withdrew $6000 (plus inflation) each year. I set the TIPS interest rate to 1.0%. Here are the Year 30 balances. I have included fixed allocation results for comparison.

Run 1. 23,468
20% rebalanced: bankrupt in year 19.
50% rebalanced: bankrupt in year 20.
80% rebalanced: bankrupt in year 20.

Run 2. bankrupt in year 22.
20% rebalanced: bankrupt in year 19.
50% rebalanced: bankrupt in year 18.
80% rebalanced: bankrupt in year 17.

Run 3. bankrupt in year 21.
20% rebalanced: bankrupt in year 20.
50% rebalanced: bankrupt in year 21.
80% rebalanced: bankrupt in year 23.

Run 4. 43,543.
20% rebalanced: bankrupt in year 19.
50% rebalanced: bankrupt in year 19.
80% rebalanced: bankrupt in year 18.

Run 5. bankrupt in year 25.
20% rebalanced: bankrupt in year 19.
50% rebalanced: bankrupt in year 19.
80% rebalanced: bankrupt in year 18.

Training improves results over mechanically defined algorithms. But there are limits. In today’s market, 6% (plus inflation) is almost certain to fail without training. With training, reaching Year 30 is at best a coin toss.

Summary

With an S&P500/TIPS portfolio, withdrawing 6% of the original balance (plus inflation) will not work even when P/E10 falls to 20. If valuations were to become attractive enough, you would be able to withdraw 6% (plus inflation). But today, with P/E10=24, the market has a long way to go before you should consider 6% (plus inflation).

This may be beyond the reach of a simple dividend based strategy. But read Taken At Face Value: Upside before dismissing the possibility outright. Still, I recommend limiting withdrawals to 5% (plus inflation) until you are sure of success.

As a side observation: this shows that a 6% (plus inflation) annuity is a good deal for someone with a 20 year life expectancy today.

Have fun.

John Walter Russell
February 3, 2008

Taken At Face Value: Upside