Planning for retirement requires all of us to become historians.
Surely not, you object: do you really have to master another subject?
Unfortunately yes. Whether you are aware of it or not, the choices made for your retirement financial plan are based on a particular reading of the history of the financial markets. There is no way to avoid it.
You can delegate this need for historical expertise to a financial planner, freeing you from the need to educate yourself on this history. But make no mistake: your financial planner will have to make historical decisions on your behalf, and a lot depends on those decisions.
A good illustration is provided by the debate sparked by my column a month ago in which I reported on a study concluding that our current financial plans are based on unrealistic optimistic assumptions. Specifically, this study compared expense rates based on the returns of a portfolio of 60% stocks and 40% bonds for a large sample of developed markets versus a US-only dataset. The authors found that the spend rate should be much lower when calculated using the sample of developed markets rather than the US-only data. In fact, to have the same chance of running out of money as with the 4% rule with US-only data, with the developed markets sample, the spend rate had to be as low as 1.9%.
As you can imagine, this study and my column elicited many comments and objections. One was from Don Rosenthal, founder of DHR Risk Consulting, who previously oversaw quantitative risk modeling for State Street Bank from 2006 to 2012 and for Freddie Mac from 2013 to 2015. In his research, he found that the rate safe withdrawal can not only be as high as 4%, but can probably be much higher, possibly as high as 6%.
Why such a discrepancy? The main answer lies in the different histories of the financial markets on which the two studies focused. Rosenthal focused on returns in the United States from 1926 to 2017. In contrast, the authors of the study I cited a month ago – Richard Sias and Scott Cederburg, professors of finance at the University from Arizona; Michael O’Doherty, professor of finance at the University of Missouri; and Aizhan Anarkulova, Ph.D. candidate at the University of Arizona – focused on returns from 38 developed countries between 1890 and 2019.
The reason this has led to such a big difference is that US stock and bond markets over the past century have significantly outperformed the average of other developed countries. If we assume that the experiences of these other countries are relevant for projecting future US market returns, then we must necessarily reduce our retirement spending rate if we are to be sure that we do not outlive our savings.
The nightmare scenario would be that the US stock market over the next three decades behaves as badly as the Japanese market over the past three decades. The price-only version of the Nikkei index is currently 30% below its peak in late 1989, more than 30 years ago, equivalent to an annualized loss of 1.1%. On an inflation-adjusted basis, its performance would be even worse.
Although we may be tempted to dismiss the Japanese experience as an exception that could not be replicated in the United States, we might want to refresh our story first. In an interview, Professor Sias pointed out that in 1989 it was not at all clear that the US economy over the next three decades would far surpass that of Japan. Indeed, many at the time were predicting the exact opposite, that Japan was on its way to dominating the world. Many books were sold back then with dire predictions that we were all about to become employees of Japan Inc.
Another reason not consider Japan as an exception, Sias added, is that there have been many other countries besides Japan whose stock markets since 1890 have also suffered negative inflation-adjusted returns over periods of 30 year. He specifically mentioned Belgium, Denmark, France, Germany, Italy, Norway, Portugal, Sweden, Switzerland and the UK.
How relevant are the experiences of these countries in projecting the future of US markets? And what’s the relevance of the many additional countries that, although they haven’t actually produced negative 30-year inflation-adjusted returns, have nevertheless done far worse than any 30-year period in the United States? United ? This is where you need to become a competent historian.
Although studying history does not give us yes or no answers to these questions, it can increase our confidence in the financial planning decisions we make. If your study of history leads you to conclude that the experiences of developed countries other than the United States are irrelevant or only somewhat relevant to an American retiree, then you can more confidently choose a higher spending rate. raised in retirement. If you conclude that these other countries are relevant instead, your rate should be lower.
Rosenthal, for his part, does not go so far as to believe that the experiences of developed countries other than the United States are irrelevant. But he thinks that, when it comes to simulating the range of possible outcomes for an American retiree, the story of the United States is most relevant. One possibility, he suggested in an email, would be to calculate a safe spend rate by giving “50% weight to US data and 50% weight to international data.” Such a rate would be lower than it would be when running simulations on US-only data, but not as low as 1.9%.
It is beyond the scope of this column to take a stand. Instead, my goal is to make you realize that a lot depends on your reading of the story.
The impact of a weaker spending rule
How many? Consider that with a 1.9% rule, you would be able to spend $19,000 a year in retirement for every million dollars of your portfolio’s starting value in retirement. With a 4% rule, you could spend $40,000 a year, and a 6% rule would let you spend $60,000. Differences in these amounts translate into the difference between a comfortable and barely scratched retirement.
And note that this assumption is based on a retirement portfolio of $1 million. As I pointed out in my column a month ago on this topic, only 15% of Vanguard retirement accounts are even worth $250,000. The pension crisis is therefore potentially much worse than we already knew.
In that regard, I want to correct another statistic that I reported in my column a month ago that exaggerated just how bad this crisis could be. I wrote that, according to an analysis of Federal Reserve data by Boston College’s Center of Retirement Research (CRR), only 12% of workers have a retirement account in the first place. What I should have said is that only 12% have a defined benefit plan, that is, a pension. Another 33% have a defined contribution plan, such as a 401(k) or IRA.
This still means that more than half of workers do not have a pension plan. The situation is therefore very bleak. It just wasn’t as bad as I said.
Mark Hulbert is a regular MarketWatch contributor. His Hulbert Ratings tracks investment newsletters that pay a fixed fee to be audited. He can be contacted at email@example.com.
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