A Grim Look for Retirees in the Bear Market of 2015: Low Yields & Unfavorable Sequence of Returns
From the Desk of Jim Eccleston at Eccleston Law LLC:
Safe Withdrawal Rates Dropping
According to the latest estimates, 2015 and perhaps 2016 and 2017 are no time to retire. Wade Pfau of the American College for Financial Services has conducted research on safe withdrawal rates and the current results are disheartening. The study accounts for management fees and uses timing risk for people retiring at a specific date. The research determines that rates in the next few years will be around 1.7%. This figure is less than half of the rule of thumb rate of 4%. For retirees this has significant meaning. The retiree planning on spending $10,000 a month should now only plan to spend $5,000 if they want to ensure their longevity.
Why Have Safe Withdrawal Rates Fallen?
The key driver of falling safe withdrawal rates is the expected sequence of return risk. Specifically, early returns will be far below the average of the past century. Looking at cyclically adjusted price-to-earnings (CAPE) ratios to value stocks and bonds, we have seen only three occasions when stock and bond valuations have been higher than they are now: 1929, 1998-2000, and 2007-2008. Those dates are of course the Great Depression, the Dot-Com Bubble, and the Housing Bubble. During those times the Schiller CAPE ratio was higher than 26x and each case was followed by a market crash of varying magnitude. The Schiller CAPE ratio at the market peak in June of 2015 was 26.83. Accordingly, equity returns in the next ten years are expected to be around .5% before management fees.
What Does This Mean For Investors?
Early negative or minimally positive returns has a detrimental effect on the long run of retirement planning. If net returns during the first ten years of retirement are zero and the retiree draws 4% per year, the portfolio would be diminished by about 45%. It is very difficult for a retiree to recover from those losses. Using the Schiller CAPE ratio as a guide, history would predict that returns in the next ten years will be stagnant at best. Pushing retirement back may be the only way to combat this bear market.
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