Morningstar - Q1 2024 - 9

Thinking Big
Can you safely spend
more early
in retirement?
IVORY TOWERS
John Rekenthaler
Recently, radio talk show host Dave Ramsey
recommended that retirees invest 100% of
their assets in equities, from which they would
withdraw 8% per year of the portfolio's
starting value, with each year's expenditures
adjusted for inflation. Thus, if inflation is
3%, the retiree would withdraw $40,000 in year
one from a $500,000 portfolio, $41,200 in
year two, $42,436 in year three, and so forth.
If you listen to Ramsey's statement, you
will realize two things. First, nobody has ever
been as certain of anything as Ramsey
is about the accuracy of his counsel. (Or he's
acting-he is a performer, after all.) Second,
he is deeply wrong. His argument relies
on the overwhelmingly false assumption that
stocks will consistently deliver doubledigit
returns.
Consequently, a host of " supernerd " researchers
(to use Ramsey's term for his critics) have
dismantled his suggestion. This article, however,
will take a different angle, by identifying the
conditions under which Ramsey's advice succeeds.
The failures of his strategy will become quite
apparent. But when does it work?
The obvious way to withdraw aggressively from
an investment portfolio without depleting it
is ... to die early. While generally not regarded as
a desirable solution, expiring quickly does
permit retirees to follow Ramsey's advice. Even
with Morningstar's conservative assumptions,
investors can safely withdraw almost 10%
annually, inflation-adjusted, over a 10-year period.
Easy pickings.
While that response sounds glib-and it is-
the underlying point is serious. The only way to
achieve a safe portfolio-withdrawal rate that
is also satisfyingly high is to assume a short time
horizon. Otherwise, something has to give.
Guaranteed income provides security, but nothing
approaching an 8% lifetime withdrawal rate.
And risky portfolios are, well, risky.
History's Verdict
Let's view history's verdict on the viability of
a 100% equity portfolio while funding 8%
inflation-adjusted withdrawals. For each rolling
30-calendar-year period since 1926, I calculated
the annual returns of a portfolio that invested
80% of its assets in the stocks of large U.S.
companies and 20% in small U.S. companies. The
data contains 68 completed 30-year horizons.
EXHIBIT 1 shows the portfolio-survival percentages
for those episodes.
Those unfortunate souls who retired in January
1929 would have been out of money in less
than eight years. Oh, dear. Remember when I
wrote that achieving an inflation-adjusted
8% withdrawal rate for a decade was " easy
pickings " ? I omitted the fine print. Doing so calls
for at least a modicum of bonds/cash
to protect against stock market collapses. Of
all possible portfolio strategies, short of
employing leverage, Ramsey's approach is the
likeliest to lead to immediate ruin.
Yes, you might respond, betting the house on
stocks failed miserably when Herbert Hoover was
president. Fortunately, things have since
changed. When recessions commence, the Federal
Reserve no longer responds by hiking interest
rates while simultaneously permitting banks
to fail. Also, Congress no longer stifles global trade
by enacting steep tariffs. The only lesson to be
drawn from the class of 1929 is the inapplicability
of ancient history to the current era.
It's true that since the Great Depression ended,
a 100% stock portfolio has almost always
survived for at least 10 years. But on a baker's
dozen occasions since 1965, retirees adopting
Ramsey's strategy would have fared not
much better, exhausting their investment pools
before year 15 concluded.
Four of those implosions happened in this
millennium, most recently in 2007, as shown in
EXHIBIT 2. Today's economy is different from
1929's, and so are the federal government's
policies, but the potential for stock market disaster
remains. Such is the nature of risky investments;
if equities did not hold such dangers, they
would not boast the high potential returns that
an 8% spending rate requires.
The good news: In the 55% of occasions in which
the portfolios survived through year 30, retirees
faced few worries when the period ended. In real
terms, 80% of those portfolios were worth more
after year 30 than when the investor retired. Their
accounts had paid them handsomely for three
decades yet were still flying high. Almost certainly,
they would outlive their owners.
As with the little girl with the curl, when
the portfolios were good, they were very good.
But when they were bad, they were horrid. In
22 of the 68 incidences, representing 32% of the
test cases, the portfolios failed to reach
year 20. Such odds may suit those who retire at
advanced ages, say in their mid-70s, or who
have severe health issues. As I wrote, short time
horizons cure investment ills.
The wager is unlikely to suit most newly minted
retirees, though, since their time horizons are too
EXHIBIT 1
The Track Record Survival of 100%
equity portfolio, 8% real annual
withdrawal rate.
Years
of Survival
1 to 9
10 to 14
15 to 19
20 to 24
25 to 29
30+
Incidences
6
13
13
10
3
55
0%
Source: Morningstar.
20
40
60
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