If you’re not familiar with the name Bill Bengen, you probably are familiar with his work. Back in 1994, he published his Trinity Study suggesting that a 4% withdrawal rate of retirement savings would be ‘safe’ for most retirees, based on historical financial returns.
Bengen – now long retired himself – has been in the news updating his thoughts on the ‘4% Rule’, as he does now and then, and the news is good. He now believes – based on additional work by Michael Kitces – that the ‘4% Rule’ is too low and most could plan on a 5% figure, or higher, over the long run.
His updated thoughts (LINK) are formed by changes in the market from the original data that he used. The ‘4% Rule’ was largely based on weak market returns and high inflation in the 14-year bear market of the late 1960s and 1970s. We haven’t seen that profile in decades, he argues, and are probably oversaving.
Bengen calls his maximum safe withdrawal rate ‘SAFEMAX’. In the chart below, he shares his analysis of SAFEMAX with the Shiller CAPE, which is a measure of S&P 500 price/earnings ratio. The chart ends in 1990, because that represents a 30-year retirement span to 2020.
You’ll notice in the chart that periods of low stock market valuation (in the orange) correlate with the opportunity for higher SAFEMAX spending (in the blue). The blue line has actually never gone below 4.4% – that’s what made it ‘safe’. The chart goes all the way back to retirements starting in 1926 and the average safe withdrawal rate is 7%.
The chart shows that retirements that started more recently – between 1974 and 1990 – have enjoyed a SAFEMAX hovering around 8%. That’s an incredibly high number. Those folks have enjoyed a wonderful environment for their retirement financials, but who knows how quickly the financial environment might change?
Going forward, Bengen’s read of the data is that when the Shiller CAPE is above 20 (‘overvalued’), a 4.5% SAFEMAX works. When it is below 20 (‘fair value’), then it is appropriate to increase it to 5.0. If the PE dropped really low – below 12 (‘undervalued’) – one might choose a SAFEMAX as high as 5.5%.
Those changes may not seem like much, but even half-percentage point changes in your retirement withdrawal rates are pretty big. He also suggests SAFEMAX adjustments for different inflation rates – dropping SAFEMAX by 0.5% for every additional 2.5% in inflation.
So where do we sit now? Inflation has been low, but unfortunately the Shiller CAPE is extremely high right now. It broke 30x in 2020 and the outlook for further S&P 500 price growth would seem to be extremely limited.
Shiller ‘Cyclically Adjusted Price/Earnings Ratio’ – 1870-2020:
It’s for that reason that we are not changing our SAFEMAX number (close to 4%) despite Bengen’s solid analysis. The market’s ‘Trump Bump’ (up 55% since November 2016) doesn’t seem to have been carried by corporate fundamentals. One could argue that it will take years of corporate earnings growth – with no change in stock prices or inflation – for the S&P 500 to be fairly valued.
What expectations for SAFEMAX have you built into your FIRE Plan?
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