Question #1 on the New Retirement Planning Calculator — What Does the Retirement Risk Evaluator Do?
It reports the safe withdrawal rate for a specified retirement plan. The safe withdrawal rate is the inflation-adjusted amount that can be withdrawn from a portfolio each year with 95 percent confidence that the portfolio will survive 30 years, presuming that U.S. stocks perform in the future at least somewhat as they always have in the past.
Question #2 on the New Retirement Planning Calculator — Aren’t There Other Safe Withdrawal Rate Calculators Already Available on the Internet?
This is the first calculator developed by members of the “New School” of safe withdrawal rate analysis. The New School maintains that the valuation level that applies at the beginning of a retirement must be taken into account in any analytically valid identification of the safe withdrawal rate. The historical data shows that valuations are a key factor in determining what withdrawal rate is safe. Thus, there is no excuse for researchers failing to consider this factor in their analyses.
Question #3 on the New Retirement Planning Calculator — Who Belongs to the New School of Safe Withdrawal Rate Analysis?
The New School arose out of The Great Safe Withdrawal Rate Debate, a series of discussions about the effect of valuations on long-term stock returns held at a number of internet discussion boards examining early retirement and general investing topics. The Great Safe Withdrawal Rate Debate was launched by a post put forward by Rob Bennett (co-developer of the new retirement planning calculator) to a Motley Fool discussion board on the morning of May 13, 2002. John Walter Russell (the other co-developer of the new retirement planning calculator) is today’s leading authority on safe withdrawal rate questions; his extensive research in this field appears at the Early-Retirement-Planning-Insights.com web site. Russell performed the statistical research into the effect of valuations on long-term stock returns that is the engine driving the new retirement planning calculator.
Other authorities who have noted the grave flaws of safe withdrawal rate studies that do not include valuation adjustments include: (1) William Bernstein (author of The Four Pillars of Investing); (2) Ed Easterling (author of Unexpected Returns); Scott Burns (personal finance columnist for the Dallas Morning News); and Peter Ponzo (a retired professor of mathematics who publishes investing research at the Gummy-stuff.org site). There have have been articles in the Wall Street Journal and at MarketWatch.com noting that many of the best-informed financial advisors have adopted a practice of taking today’s high stock valuations into account when offering retirement advice to their clients.
Question #4 on the New Retirement Planning Calculator — Do the Old School Studies of Safe Withdrawal Rates Still Have Value?
The old school studies report the Historical Surviving Withdrawal Rate (HSWR). There is value in knowing that number. But it is irresponsible in the extreme for the Historical Surviving Withdrawal Rate to be reported as the Safe Withdrawal Rate. At times such as today (this article was posted in April 2007) the Historical Surviving Withdrawal Rate (4 percent) is anything but safe. An analytically valid study of the historical stock-return data shows that withdrawal rate to be a high-risk withdrawal rate for high-stock-allocation portfolios at today’s valuations. It is possible that the retirements of retirees using the old school studies will survive for 30 years; the odds today are about 50/50. But these retirements are risky retirements. The words “safe” and “risky” are obviously not synonyms; they are antonyms.
Question #5 on the New Retirement Planning Calculator — Why Have the Old School Studies Not Been Corrected?
We are today at one of the highest valuation levels that has ever applied in the history of the U.S. market. Many investors are emotionally invested in stocks and are highly reluctant to acknowledge what the historical stock-return data says about the effect of valuations on long-term returns. As Dallas Morning News Columnist Scott Burns noted in a column describing the New School findings, the media has been hesitant to report the breakthrough safe-withdrawal-rate findings of recent years because “it is information most people don’t want to hear.”
Question #6 on the New Retirement Planning Calculator — How Many Retirements Are at Risk of Going Bust as a Result of the Discredited Old School Findings.
Millions. It is not only retirees who make direct use of the old school studies who are at risk. Many articles in newspapers and magazines reference the infamous “four-percent rule” in offering retirement advice to their readers. The number of retirees who have made direct use of the discredited studies and calculators is likely in the hundreds of thousands.
Question #7 on the New Retirement Planning Calculator — How Can You Know in Advance What Withdrawal Rate Is Going to Work?
We do not know what withdrawal rate is going to work. What we know is what the probabilities are for various withdrawal rates, presuming that stocks perform in the future somewhat as they always have in the past. In the past, the valuation level that applied on the starting-date of a retirement has always had a big effect on the long-term success of that retirement. Presuming that that remains the case, the old school studies, which make no adjustments for starting-date valuations, encourage an unfounded confidence in retirees retiring at times of high valuations. We do not know what withdrawal rate is going to work. What we know is that the claims put forward in the old-school studies are the product of an analytically invalid methodology.
Question #8 on the New Retirement Planning Calculator — Is the Methodology Used in the Retirement Risk Evaluator the Only Analytically Valid Methodology for determining safe withdrawal rates?
No. Any methodology that employs a reasonable means of factoring in the effect of valuations is analytically valid. We will no doubt learn more about what works best as time goes on. There are no other retirement planning calculators publicly available today that employ an analytically valid methodology. But there have been stock analysts who have employed analytically valid methodologies other than the methodology employed in the Retirement Risk Evaluator. For example, William Bernstein reports accurately on the safe withdrawal rate in his book The Four Pillars of Investing. His findings are not identical to the findings of the new retirement planning calculator, but they are similar (and they are nowhere even remotely in the same neighborhood as the findings reported on in the old-school studies).
Question #9 on the New Retirement Planning Calculator — Are There Other Features of the Retirement Risk Evaluator That Are Worthy of Note?
Yes. The new retirement planning calculator offers the aspiring retirees using it the opportunity to examine many more strategic options than are examined in old school studies and calculators. For example, most old-school studies reveal the withdrawal rate that is safe for retirees willing to see the value of their portfolios reduced to zero over the course of a 30-year retirement. Many retirees have expressed a desire to examine more prudent options, such as crafting a retirement plan virtually sure to leave them with a portfolio balance of 30 percent or 50 percent or even 100 percent of the starting-date balance. The new retirement calculator permits retirees to examine what changes in the withdrawal rate are required to construct safe retirements leaving them with any of a number of end-point portfolio balances.
Question #10 on the New Retirement Planning Calculator — What’s Next for the New School of Safe Withdrawal Rate Analysis?
Our findings on safe withdrawal rates have led to exciting research on a host of investing questions. The Stock-Return Predictor, the calculator available at the “Return Predictor” tab at the left, is a product of the community learning experience we enjoyed during The Great Safe Withdrawal Rate Debate. The Valuation-Informed Indexing approach to investing is also the fruit of those discussions. There are hundreds of articles at Russell’s site (early-retirement-planning-insights.com) reporting on research that has its roots in the New School findings. Russell and Bennett are at work on a third calculator, The Investor’s Scenario Surfer, which will permit investors to run simulations of how stocks may perform on a year-by-year basis in the future assuming that they continue to perform in the future somewhat as they always have in the past (and that valuations continue to exert a strong influence on long-term returns). The Scenario Surfer too is the fruit of The Great Safe Withdrawal Rate Debate, soon to enter its sixth year.
The most pressing need today, however, is to inform retirees who have made use of the old school studies of the risks to which they have put their retirements by doing so. Russell and Bennett hope that release of the new calculator will help to spread the word about the New School findings.