Withdrawing 5% Safely at P/E10=20

Prices are high. You cannot withdraw 5% of your original balance (plus inflation) safely with a traditional fixed allocation strategy. You can with Valuation Informed Indexing.

I do not address dividend and income approaches in this study.

Near Future

Today’s P/E10=22. Soon P/E10 will be down to 20. Prices will fall to the edge of the danger zone.

The Traditional Approach

The traditional approach used in Safe Withdrawal Rate studies sells stock shares as necessary with a stock/bond (S&P500/TIPS) portfolio. You vary withdrawals to match inflation. The withdrawal rate is the original amount withdrawn divided by the original portfolio balance.

Special Consideration

I treated the non-stock portion of my investments as equivalent to 3% TIPS. I believe that this is reasonable based on the traditional spread of corporate bonds and preferred shares above treasury securities.

Year 30 SWR Retirement Risk Evaluator

I set P/E10=20, TIPS interest rate=3.0% and the Year 30 final amount of 0%. These are the results:

Safe Withdrawal Rate
20% stocks with rebalancing: 4.68%.
50% stocks with rebalancing: 4.56%.
80% stocks with rebalancing: 3.83%.
100% stocks: 3.30%.

Likely Success Rate (50%-50%)
20% stocks with rebalancing: 5.08%.
50% stocks with rebalancing: 5.26%.
80% stocks with rebalancing: 5.23%.
100% stocks: 5.10%.

Almost Certain Failure Rate
20% stocks with rebalancing: 5.68%.
50% stocks with rebalancing: 6.16%.
80% stocks with rebalancing: 6.83%.
100% stocks: 7.10%.

This shows that reaching a 5% (plus inflation) withdrawal rate is a coin toss (close to 50%-50%) when P/E10=20.

Scenario Surfer Runs

I invested entirely in stocks and TIPS. I started with a $100000 balance. P/E10=20 Bear Market initially. I withdrew $6000 (plus inflation) each year. I set the TIPS interest rate to 3.0%. Here are the Year 30 balances. I have included fixed allocation results for comparison.

Run 1. bankrupt in year 19.
20% rebalanced: bankrupt in year 21.
50% rebalanced: bankrupt in year 17.
80% rebalanced: bankrupt in year 15.

Run 2. bankrupt in year 26.
20% rebalanced: bankrupt in year 23.
50% rebalanced: bankrupt in year 22.
80% rebalanced: bankrupt in year 20.

I reduced my withdrawal amount to $5500 (plus inflation) each year.

Run 1. 65,978.
20% rebalanced: bankrupt in year 30.
50% rebalanced: 24,549.
80% rebalanced: 40,060.

Run 2. 80,282.
20% rebalanced: bankrupt in year 29.
50% rebalanced: 24,663.
80% rebalanced: 54,318.

Run 3. 12,895.
20% rebalanced: bankrupt in year 29.
50% rebalanced: 9,997.
80% rebalanced: 14,928.

Run 4. bankrupt in year 25.
20% rebalanced: bankrupt in year 26.
50% rebalanced: bankrupt in year 24.
80% rebalanced: bankrupt in year 21.

Run 5. bankrupt in year 28.
20% rebalanced: bankrupt in year 28.
50% rebalanced: bankrupt in year 30.
80% rebalanced: bankrupt in year 30.

I reduced my withdrawal amount to $5000 (plus inflation) each year.

Run 1. 147,981.
20% rebalanced: 3,817.
50% rebalanced: 1,249.
80% rebalanced: bankrupt in year 26.

Run 2. 250,039.
20% rebalanced: 10,095.
50% rebalanced: 18,203.
80% rebalanced: 1,141.

Run 3. 158,167.
20% rebalanced: 19,565.
50% rebalanced: 59,733.
80% rebalanced: 93,298.

Run 4. 155,412.
20% rebalanced: 5,111.
50% rebalanced: 1,421.
80% rebalanced: bankrupt in year 26.

Run 5. 134,024.
20% rebalanced: 4,967.
50% rebalanced: 8,813.
80% rebalanced: 2,004.

Summary

I only examined liquidation approaches in this study. Dividend and income approaches allow you to reach a higher income stream.

With an S&P500/TIPS portfolio, withdrawing 6% of the original balance (plus inflation) is not safe when P/E10=20. Even 5% is a coin toss. Valuation Informed Indexing helps. It lifts the Safe Withdrawal Rate to 5% (plus inflation), but not to 5.5%.

These results are consistent with two earlier studies: 5% the Hard Way and 5.5% with Corporate Bonds?

Have fun.

John Walter Russell
July 30, 2008

5% the Hard Way
5.5% with Corporate Bonds?