by Anne Tergeson | UPDATE 4 19, 2022 05:30 EDT
The combination of high inflation and high market valuations may require revision of the retirement rule of thumb.
For decades, retirees have relied on the 4% rule to determine how much it was safe to spend in retirement. Now, the inventor of the rule says that current market conditions may require an even more conservative approach.
The combination of 8.5% inflation with high stock and bond market valuations makes it difficult to predict whether the standard playbook will work for recent retirees, said retired financial planner Bill Benzene, who first introduced the 4% rule in 1994. was prepared.
He now recommends that retirees take a less aggressive approach to lowering their nest egg, at least until we determine why the current boom in prices is particularly stressful for people on fixed incomes. , is a long term trend or a short term blip.
The long-standing method calls for spending 4% in the first year of retirement and then adjusting that amount annually to keep pace with inflation. Such an approach could have saved retirees from running out of money every 30-year period since 1926, even when the economic situation was at its worst, Mr. Bengen said.
“The problem is there is no precedent for today’s circumstances,” he said. Their concern comes from a recent report from Morningstar Inc., which recommends a 3.3% early withdrawal rate for retirees today who want to spend over three decades to keep pace with inflation. And the high degree of certainty their money will last.
Mr. Bengen’s latest amendment does not mean it is necessary to go below 4%, he said. That’s because the 4% rule hasn’t really been the 4% rule for a while. His original research was based on a portfolio with 55% in US large-cap stocks and 45% in intermediate-term Treasury bonds.
Since 2006, he has revised that portfolio to add international stocks and midsize, small-cap and microcap US stocks as well as Treasury bills. This increased returns and supported the safe withdrawal rate, rising to 4.7%.
Given the challenges of forecasting right now, Mr. Bengen suggests cutting spending if possible. He said new retirees with highly diversified portfolios that would normally support a 4.7% withdrawal rate may want to start around 4.4%.
Mr. Benzene, who retired in 2013, said he plans to do just that.
“I don’t eat that much at restaurants. I live a fairly simple life. I don’t travel a lot and I’m happy with a deck of cards and three other bridge players.”
Over the historic 30-year period, Mr. Bengen said, the 4.7% early withdrawal rate was a safe starting point. He noted that those who retired at the best of times, when stocks were cheap and interest rates and inflation were low, could withdraw up to 13% to begin with without running out of money, adding, “We haven’t seen anything. It’s been like that since the 1930s.” Since 1926, Mr. Bengen’s research indicates that an average 7% withdrawal rate has been successful.
When inflation is high, withdrawals made under the 4% rule are “increasing leaps and bounds,” said Mr. Bengen. This means the portfolio must earn higher returns to prevent shortfalls, Mr. Bengen said.
Another danger is high stock valuations. According to Nobel laureate Robert Schiller’s CAPE, or cyclically adjusted price-to-earnings, ratio, stocks are currently trading at about 36 times corporate earnings over the past decade.
“That’s twice the historical average,” Mr. Benzene said. “Although lower interest rates somewhat justify higher stock valuations, I think the market is expensive.”
In previous periods of very high stock valuations, he said, “it usually takes a bear market for prices to adjust back to average.” As a result, he said, “we could face extended periods of abnormal returns.”
When bear markets occur, retirees tend to pull money out of shrinking portfolios. This is especially dangerous at the start of retirement because most retirees need their savings to last years, Mr. Bengen said.
Conversely, if a bear market comes along after 20 years of retirement, “your portfolio may already increase in value, giving you a bigger cushion,” Mr. Bengen said. In addition, the retiree may not need the money to last for a long time.
While high short-term inflation poses some risks, the risks are multiplied when high inflation persists for a long period of time, as was the case in the 1970s.
“We have had bursts of high inflation in the past, including after World War II, which lasted only a year or two,” Mr. Bengen said. While these bouts of high inflation lowered the safe withdrawal rate, “it was not by a dramatic amount,” he said.
Mr. Bengen’s research indicates that the worst 30-year period in which to retire began on October 1, 1968. It was not only in 1968 that was the problem, he said, but in later years, “that were terrible.” Inflation was high for much of the 1970s and stocks suffered back-to-back bear markets that began around 1969 and 1973. From the end of 1965 to the end of 1981, the annual return on the S&P 500 was nearly flat without dividends.
He said that in addition to cutting spending, retirees can try to protect their nest egg by reducing exposure to stocks and bonds. While Mr. Bengen said he would typically invest about 55% of his savings in stocks and 45% in bonds, his concerns about both markets left him 20% in stocks and 10% in bonds, the rest in cash. Have given.
“I’m uncomfortable having that much cash,” he said. But with the Federal Reserve declaring its intention to aggressively raise interest rates, “this is not a good time to invest in financial assets,” said Mr. Bengen, who said he would be interested in what would happen if the market fell significantly. And the stock becomes cheap so plan to buy the stock.
Mr. Bengen warned that attempts to time the market could backfire on investors. “It is tough to buy stocks during bear markets. There is an emotional barrier to doing so as investors fear it could lead to further losses.”
“I retired nine years ago, so I’m probably safe,” he said. “But I’m not comfortable because I’m still early enough in retirement that the combination of threats we face could be harmful.”