Retirement planning requires us all to become educated historians.
Surely not, you object: Do we really have to become proficient in yet another subject?
Unfortunately, yes. Regardless of whether you’re aware of it, the choices made for your retirement financial plan are based on a particular reading of financial market history. There’s no way to avoid it.
You can delegate this need for historical expertise to a financial planner, thereby freeing yourself of the need to become a good historian yourself. But make no mistake about it: Your financial planner will need to be making historical decisions on your behalf, and much is riding on those decisions.
A good illustration is provided by the debate spurred by my column from a month ago in which I reported on a study that concluded our current financial plans are based on unrealistically optimistic assumptions. Specifically, that study compared spending rates based on returns from a 60% stock/40% bond portfolio for a broad sample of developed markets versus a U.S.-only dataset. The authors found that the spending rate needed to be much lower when calculated using the developed market sample rather than the U.S.-only data. In fact, in order to have the same chance of running out of money as the 4% rule with U.S.-only data, with the developed market sample the spending rate needed to be as low as 1.9%.
As you can imagine, that 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 has found that the safe withdrawal rate can not only be as high as 4%, it probably can be significantly higher—perhaps as high as 6%.
Different histories
Why such a divergence? The primary answer lies in the different financial market histories on which the two studies focused. Rosenthal focused on returns in the U.S. from 1926 to 2017. In contrast, the authors of the study I cited a month ago—Richard Sias and Scott Cederburg, finance professors at the University of Arizona; Michael O’Doherty, a finance professor at the University of Missouri, and Aizhan Anarkulova, a Ph.D. candidate at the University of Arizona—focused on returns from 38 developed countries between 1890 and 2019.
The reason this led to such a big difference is that the U.S. equity and bond markets over the last century significantly outperformed the average among other developed countries. If we assume that those other countries’ experiences are relevant to projecting U.S. market returns going forward, therefore, then we must necessarily lower our spending rate in retirement if we want to be confident of not outliving our savings.
Nightmare scenario
The nightmare scenario would be if the U.S. stock market over the next three decades performed as poorly as the Japanese market over the last three decades. The price-only version of the Nikkei Index currently is 30% below where it traded at its end-of-1989 peak, more than 30 years ago—equivalent to an annualized loss of 1.1%. On an inflation-adjusted basis its return would be even worse.
While we may be tempted to dismiss the Japanese experience as an exception that couldn’t happen in the U.S., we may want first to brush up on our history. Professor Sias in an interview pointed out that, in 1989, it was not at all clear that the U.S. economy over the subsequent three decades would far outperform Japan’s. Indeed, there were many at the time who predicted just the opposite, that Japan was on its way to world domination. Many books were sold at the time with dire predictions that we were all about to become employees of Japan, Inc.
Another reason not to consider Japan as an exception, Sias added, is that there have been many other countries besides Japan whose stock markets since 1890 also suffered negative inflation-adjusted returns over 30-year periods. He specifically mentioned Belgium, Denmark, France, Germany, Italy, Norway, Portugal, Sweden, Switzerland, and the United Kingdom.
How relevant are these countries’ experiences to projecting the future of U.S. markets? And how relevant are the many additional countries that, while they didn’t actually produce negative-inflation-adjusted 30-year returns, nevertheless did significantly worse than any 30-year period in the U.S.? This is where you need to become a proficient historian.
While studying history won’t 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 non-U.S. developed countries’ experiences are either not relevant or only somewhat relevant to a U.S. retiree, then you can more confidently choose a higher spending rate in retirement. If you instead conclude that those other countries are relevant, then your rate will need to be lower.
Rosenthal, for one, doesn’t go so far as to believe non-U.S. developed countries’ experiences are irrelevant. But he does believe that, when simulating the range of possible outcomes for a U.S. retiree, U.S. history is the most relevant. One possibility, he suggested in an email, would be to calculate a safe spending rate by giving “50% weight to U.S. data and 50% weight to international data.” Such a rate would be lower than what it would be when running simulations on U.S.-only data, though not as low as 1.9%.
It’s beyond the scope of this column to take a position. Instead, my goal is to make you aware that much is riding on your reading of history.
The impact of a lower spending rule
How much? Consider that, with a 1.9% rule, you would be able to spend an inflation-adjusted $19,000 per year in retirement for every $1 million in your portfolio’s starting value upon retirement. With a 4% rule you could spend $40,000 per year, and a 6% rule would allow you to spend $60,000. The differences in these amounts translate into the difference between a comfortable retirement and just barely scraping by.
And notice that this hypothetical is based on a $1 million retirement portfolio. As I pointed out in my month-ago column on this subject, only 15% of the retirement accounts at Vanguard are worth even $250,000. So the retirement crisis is potentially a lot worse than we already knew.
In that regard, I want to correct another statistic I reported in my month-ago column that exaggerated how bad this crisis might be. I wrote that, according to an analysis of Federal Reserve data by the Center of Retirement Research (CRR) at Boston College, only 12% of workers have any retirement account in the first place. What I should have said is that only 12% have a defined-benefit plan—a pension, in other words. An additional 33% have a defined contribution plan, such as a 401(k) or IRA.
That still means that more than half of workers have no retirement plans. So the situation is indeed grim. It just wasn’t as bad as I made it out to be.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected].
