San Juan Mountains

San Juan Mountains
San Juan Mountains: Grenadier Range

Monday, September 21, 2015

What Is A Safe Withdrawal Rate?

Financial advisers fall into one of two classes:  idiots or lemmings.  The idiot class of financial adviser consists of those fools who believe it is possible to predict the future and thereby believe they can predict what the stock market is going to do tomorrow.  They will make moves in and out of the market, costing their clients significant amounts of money, all in the name of "asset management."  Many of them will throw some options or leverage into their trading scams which causes clients to lose even more money.  For the privilege of garnering inferior returns for their clients these folks have the audacity to charge 1-2 percent of the value of their portfolio per year for their management services. I have written about the lunacy of attempting to predict the future direction of the stock market before so today I want to tell you about the lemming class of financial adviser.
Lemmings follow each other off the edge of a cliff. The key to being a good lemming is to never do anything different from the other lemmings.  Financial advisers of this class earn their reputations because they follow all of the official rules for financial advising, no matter how stupid they might be.  For example, lemming class financial advisers always advise their clients to have a six month's income "emergency reserve fund," whether it makes sense for that particular individual or not.  Lemming financial advisers also always recommend a portfolio that consists of a mix of stocks and bonds based upon their client's age.  If a person is 50 years of age the lemming adviser will recommend 50% stock and 50% bonds in that person's portfolio.  More important than anything, including decent returns on investment, is the ability to claim that under the advice of the lemming adviser a client did not experience as much of a loss in a market downturn as the market itself experienced.
There is a magazine and a website dedicated to financial advisers.  In fact, there are many such websites but one caught my eye last week.  The content found on this website is a perfect example of lemming adviser counsel.  Go here for the article that I quote from below.  The most important question for anyone approaching retirement is how much money do I need to provide the monthly income stream I desire in my retirement years?  Two factors come into consideration to answer that question.  What should the gross value of my portfolio be and what rate of withdrawal may I take funds from it?  The second question has generally been answered by lemming advisers as 4-5% of the value of the portfolio annually as the maximum safe rate of withdrawal.  In other words, if you have a one million dollar portfolio the maximum safe withdrawal rate is $40,000- $50,000/year.   "Safe" is defined as the ability to make the anticipated withdrawals and not experience any loss of principle in the portfolio value, generally after also adjusting for inflation, over the length of your retirement period.  Here is the current lemming adviser opinion on the maximum safe rate of withdrawal:
"Concern about outliving one’s wealth is a major fear in the minds of Americans over 50 years old. Most retirees cannot re-enter the labor force under the same terms that they exited it, so their assets must constitute their lifetime income stream. And if they suffer poor returns early in their retirement, it means that their sustainable withdrawal rate will likely be sharply lower. Their standard of living will be more vulnerable to market volatility, and extra caution is warranted.  New research shows that Americans retiring in 2015 need to be far more conservative in their withdrawal rates during retirement. The historic 4% annual withdrawal rate is over two times the level that Americans can safely withdraw without expecting to outlive their assets. The real safe withdrawal rate, accounting for fees and today’s stock and bond market levels, is under 2% per year."
So there you have it.  The maximum safe withdrawal percentage is now declared to be 2%.  That opinion is based upon the belief that today's "stock market level" is too high, whatever that means.  At that rate of withdrawal nobody will ever lose money over the long term and lemming financial advisers will be able to inform prospective new clients that no one under his counsel has ever lost money.  Sadly, it will also be the case that no one under his counsel will ever make money either.  And most folks will never be able to retire as well.
The time period which most advisers use to calculate the ideal withdrawal rate is 30 years.  In other words, if you retire at 60 most advisers will assume you will live to 90 years of age and base their recommended rate of withdrawal upon that age.  I find that to be a reasonable assumption and will use it myself in this blog post.  In fact, it is almost 30 years to the day since I made my first stock mutual fund investment.  I can speak from experience when I talk about long term rates of return and reasonable rates of withdrawal during retirement.  In fact, let me tell you about my experience in the stock market today.
I do not follow the lemming financial adviser plan.  By that I mean I never hold any money in bonds.  I have remained fully invested in stocks and stock mutual funds my entire investing career.  I will never move out of the stock market, even if it drops 57% as it did in 2008-2009, and I will stay fully invested in stock funds throughout my future retirement as well.  So how have I done the past 30 years?  Let me tell you.
My investing career can be nicely divided into three periods.  The early 1980s through about 1990 saw me realize an average annual rate of return around 12%/year.  The 1990s through March of 2000 saw me realize right around 20%/year in my portfolio.  From 2000 to the present I have averaged 7%/year.  My average annual rate of total return for the entire 30 year period is 13%.
Now let me ask you a simple question.  If I had a million dollars 30 years ago and I decided to retire on that date, how much money could I have safely  withdrawn from my portfolio the last 30 years?  Since 1985 inflation has averaged right at 3%/year.  If I received 13%/year and inflation robbed me of 3% that means I realized a real average annual rate of return of 10%/year.  That is true despite the fact I went through a 20.5% drop in value in one day in October of 1987.  That is true despite the fact that I went through a 49% drop in value during the bear market of 2000-2002. That is true despite the fact that I went through a 57% drop during the Great Recession.  So why, in light of historic reality, would financial advisers recommend a 4% rate of withdrawal as the maximum safe rate?  Clearly I could have withdrawn 10% of the value of my portfolio annually and I would still have a real million dollars (plus a 3% nominal annual increase to adjust for inflation) in my portfolio today.  Why, I ask you, would lemming financial advisers tell us now that 2% is the only real safe withdrawal rate?
The answer to that question is advisers, either of the lemming or the idiot type, ever recommend that their clients remain 100% in stock funds 100% of the time.  The reason they fail to make that recommendation is fear of down markets and that fear is downright stupid.  Time is the great equalizer in the stock market.  If you stay in it, you will do well.  If you jump in and out of it, you will do poorly.  If you never get in it at all, you will draw 2% from your retirement portfolio when  you retire.  Financial advisers who have a brain, like Warren Buffet and Jack Bogel, have taught me what I have written here.  They are not afraid of the stock market because they are neither idiots nor lemmings.  They control their emotions and invest when others are afraid.  By following their advice I can conclude that 8% is the maximum safe withdrawal rate for a retiree.  That is two to four times more than the idiots and the lemmings.  There is a price to be paid for being an idiot or a lemming.

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