We are living through the greatest test of the 4% safe withdrawal rate in history. Sounds like a big overarching statement but that’s what the data tells me. A little over a year ago I questioned whether or not the year 2000 retiree would be the first to destroy the 4% rule. In other words, the year 2000 may turn out to be the worst time in history to retire. While the history of the year 2000 retiree is not complete we can take a look at his/her progress 12 years into retirement. It didn’t look good then and as of the end of 2011 it doesn’t look any better. In this post we’ll take a look at the concerning progress of the year 2000 retiree.
Lets look into the a person who retired on January 1, 2000. How has their retirement portfolio performed during the 12 years from 2000 through the end of 2011? Consider 3 retirement portfolios; a 100% US stock portfolio, the standard recommended 60/40 stock/bond portfolio and the IVY timing portfolio that I recommend in retirement. We use an SWR of 4%, a withdrawal rate that has worked back to the great depression and a starting value for the portfolio of $1M. The table below shows the annual return of the three portfolios from 2000 to 2011, the SWR of 4%, the value of the portfolio at the end of 2011, and the current withdrawal rate (CWR). The CWR is an early warning indicator of trouble for retirement portfolios. Now, on to the table.
Let me walk you through this table. The first thing to note is the investment returns from 2000 to 20011. Returns during these 12 years were lower than historical performance as one would expect due to the dot com and the financial crisis. Returns varied from a low annual return of 0.58% for a 100% stock portfolio to 11.76% for the timing portfolio. The next column simply shows the SWR used in this analysis and the last columns show the progress of this retiree’s portfolio in terms of the value of the portfolio at the end of 2011 and the CWR. For example, the 60/40 stocks/bonds portfolio with a 4% SWR would have left the retiree with a portfolio value of $642K (an almost 40% drawdown) and with a CWR of 8%. Basically this retiree has a high likely hood of running out of money in retirement, after all he/she has 18 years to go. This is on par or slightly worse than the previous worse case retiree, 1971, who after 10 years had a CWR of 8.5%. Of course, after 10 years, the 1971 retiree, benefited from the greatest bull market in history starting in 1982. Not a pretty picture for the year 2000 retiree. This is why I say that the year 2000 retiree may break the 4% SWR rule. Unless forward returns pick up the year 2000 retiree is in deep trouble.
In contrast, look at the retirement performance of the year 2000 retiree using the IVY timing model. With this investment portfolio the retiree’s portfolio is up to $1.9M and the CWR is 3% below the initial 4%. Looks like smooth sailing ahead. These are far from trivial differences. This difference is stunning. How would you feel after 12 years of retirement looking at a portfolio that is almost 40% less than when you started? This is the primary reason I think most retirees should follow the IVY timing model in retirement. Higher income and safer/higher probability outcomes in retirement. Isn’t that what we all look for in retirement? But wait. It gets better. As I’ve suggested , higher withdrawal rates are possible with the IVY timing model. Crunching the numbers, the SWR for the year 2000 retiree using the IVY timing model is 6.75%. Their portfolio value at the end of 2011 was $1.3M and their CWR was 7%. This is well within the safety range. That is the difference in beginning retirement with $67.5K/yr in income versus starting retirement with $40K/yr income with the same starting portfolio a more than 50% difference.
In summary, there is a high likelihood the 4% SWR will fail for the first time in history for the year 2000 retiree. The alternative that will be trumpeted by the financial industry is to use a lower SWR in retirement, maybe 2% or 3%. Ge, thanks for the help. How many retirements will be prevented or postponed? It doesn’t have to be that way. By using a different yet simple and automatic investment model, the IVY timing portfolio, the 4% SWR is extremely safe and in fact much higher SWRs, up to 6.75%, maybe used in retirement.