Thursday, April 19, 2012

Darrow Kirkpatrick on "Is the 4% Safe Withdrawal Rate Obsolete?"

Darrow Kirkpatrick posted a good article, "Is the 4% Safe Withdrawal Rate Obsolete?" at his website, Can I Retire Yet? He is discussing the issue about the impact of market conditions at one's retirement on their sustainable withdrawal rate, which I recently revisited at "Safe Withdrawal Rates and Retirement Date Market Conditions." He makes good points. I like this quote:

Also published in 1998 was a seemingly unrelated paper on investing returns that has become the basis for undermining the 4% rule nearly 15 years later.…

I hadn't put two and two together to note that the Trinity study and the Campbell and Shiller article connecting the cyclically-adjusted price-earnings ratio to subsequent stock returns both came out in the same year.

He also makes good points:

  • First, Pfau's findings need to be confirmed by other researchers with access to the same tools and data, to ensure the results and their interpretation are the same.
  • Pfau's chart of Predicted Maximum Sustainable Withdrawal Rate shows the curve bottoming out near the bottom of the market, in 2009. But that is counterintuitive: the bottom of a large market decline, assuming your savings are intact, should be the ideal time to retire, because of the probable bull market ahead.

I agree with that. I always said that I thought the predictions from my regression model may be too low because in recent years we are dealing with circumstances we haven't seen before. It is hard for regressions to make predictions outside the range from which they are fitted to the data. I thought the main lesson was to question the safety of 4%. Comments from that blog post finally pushed me to take a new look at this whole issue from another perspective, which I discussed at "Lower Future Returns and Safe Withdrawal Rates." The news there is still pessimistic in comparison to what comes from looking at the US historical data, but it isn't anywhere near as bad at that 1.8% number I was coming up with before for 2010 retirees. In the end, I think this latter approach may be more suitable for thinking about safe withdrawal rates.

For anyone wanting to replicate my August 2011 results, the dataset I used is freely available from Robert Shiller's website. A link to there as well as an explanation about my methodology can be found in my article.

Darrow also provides a good explanation with this point:

For those who are puzzled by how relatively short-term changes in stock market valuations could fundamentally change long-term retirement success rates based on 100 years of stock market history — there is an explanation. The issue lies in the sensitivity of your portfolio to the first decade of retirement. Analyses show that if your retirement gets off to a bad start, it will probably never recover. 

Finally, Darrow ends with:

The ultimate answer, I believe, for coping with the possible demise of the 4% Rule, is a Dynamic Withdrawal Strategy. Your withdrawals simply must be calibrated to economic realities and must change as you make your way through retirement. This is a large and very important topic of its own, and will be the subject of future posts here, so stay tuned!
I agree!  And that is what I'm working on now too, actually.

Based on this article, I'd say that Darrow clearly knows what he is talking about, and his blog may be worth checking more.