Predicting Sustainable Retirement Withdrawal Rates Using Valuation and Yield Measures

Update on May 16, 2011: I have substantially re-written this article. A description of the revised article can be found here. In my last post, I mentioned hoping to finish two more articles before the holidays.  Well, one of those articles will have to wait until January.  But one of them is finished now!

 
This article is “Predicting Sustainable Retirement Withdrawal Rates Using Valuation and Yield Measures.”  The full article can be downloaded from RePEc  or SSRN.
 
This article basically represents the third part of a trilogy of articles that each uses an almost completely different methodology to conclude that U.S. retirees in the past decade may experience the worst retirement outcomes in history.  This article is now the most specific, as I am finally estimating the sustainable withdrawal rates for recent retirees. Here is the abstract:
 

This study attempts to quantify whether a 4 percent withdrawal rate can still be considered as safe for U.S. retirees in recent years when earnings valuations have been at historical highs and the dividend yield has been at historical lows. We find that the traditional 4 percent withdrawal rule is likely to fail for recent retirees. The maximum sustainable withdrawal rate (MWR) for retirees may continue declining even after the peak in earnings valuations in 2000. Our lowest point estimate for an MWR with a 60/40 allocation between stocks and bonds is 1.46 percent for new retirees in 2008. We also discuss confidence intervals for these predictions. The regression framework with variables to predict long-term stock returns, bond returns, and inflation (the components driving the retiree’s remaining portfolio balance) produces estimates that fit the historical data quite well, and we use backtesting for a further robustness check. Nevertheless, there are important qualifications for these predictions. In particular, they depend on out-of-sample estimates as the circumstances of the past 15 years have not been witnessed before, and there is always potential for structural changes which could leave recent retirees in better shape than suggested by the model. Looking forward, this methodology can guide new retirees toward a reasonable range for their MWR so that the 4 percent rule need not be blindly followed.

And finally, here is a figure which tells the basic story: the regression model fit the historical data quite well, and its predictions since 1980 (the last year that we actually know the 30-year sustainable withdrawal rate) shows the bad news, this case for a 60/40 stock and bond asset allocation:

Predicting Sustainable Retirement Withdrawal Rates

Happy Holidays!

 

McLean Asset Management Corporation (MAMC) is a SEC registered investment adviser. The content of this publication reflects the views of McLean Asset Management Corporation (MAMC) and sources deemed by MAMC to be reliable. There are many different interpretations of investment statistics and many different ideas about how to best use them. Past performance is not indicative of future performance. The information provided is for educational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy or sell securities. There are no warranties, expressed or implied, as to accuracy, completeness, or results obtained from any information on this presentation. Indexes are not available for direct investment. All investments involve risk.

The information throughout this presentation, whether stock quotes, charts, articles, or any other statements regarding market or other financial information, is obtained from sources which we, and our suppliers believe to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Neither our information providers nor we shall be liable for any errors or inaccuracies, regardless of cause, or the lack of timeliness of, or for any delay or interruption in the transmission there of to the user. MAMC only transacts business in states where it is properly registered, or excluded or exempted from registration requirements. It does not provide tax, legal, or accounting advice. The information contained in this presentation does not take into account your particular investment objectives, financial situation, or needs, and you should, in considering this material, discuss your individual circumstances with professionals in those areas before making any decisions.