Be Afraid, Very Afraid, of Retiring in the 2020s

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Most retirement planning software uses data or assumptions that will lead to unrealistically optimistic outcomes, considering our low-interest-rate environment.

Last month, I posted my latest co-authored research paper, A Case Study in Sequence Risk, on SSRN. As the title of this article alludes, our analysis led us to some disturbing conclusions. Since “fear sells,” our findings have attracted a modicum of attention in the financial news media, including Brett Arends’s March 12, 2021 MarketWatch article, ‘Worst-case scenario’ warning for retirees and the 4% rule.

Our paper examined the 20-year investment period that began with the bear markets of 2000-2002, which was followed by the 2007-2009 bear market. Despite the dramatic rebound and advance in the stock market over the ensuing decade, we found that the first two decades of the 21st century was among the worst 20-year periods in U.S. investment history. Specifically, consumers who retired at the beginning of that period and blindly followed the vaunted “4% rule” or even other better empirically supported static spending strategies are at considerable risk of running out of money well before they run out of time.

More ominously, especially for consumers approaching retirement, the 20-year period we examined does not represent a “worst-case” scenario. In fact, the strong performance of bonds, as interest rates fell during the study period, buffered total portfolio returns in a way that is not likely repeatable when starting a retirement spending regimen in the current historic low-interest-rate environment. Were we to experience similar back-to-back severe, prolonged stock market downturns with interest rates stuck at today’s low levels or, worse, while interest rates are rising, the result might be a true black swan event that could make a 3% inflation-adjusted withdrawal rate unsustainable for a 30-year retirement horizon.

We are neither alone nor first in reaching this conclusion. Michael Finke, Wade Pfau, and David Blanchett postulated just such a scenario in a 2013 Journal of Financial Planning paper, The 4% Rule is Not Safe in a Low-Yield World. For his part, David Blanchett has been warning about this possibility, as in the following excerpt from his August 2020 article for ThinkAdvisor

I’ve done quite a bit of research on the implications of low bond yields (and likely low equity returns) with Michael Finke and Wade Pfau. As a result, I think it’s always important to remind advisors, retirees and pretty much anyone who will listen that most research on optimal retirement income strategies has been based on historical U.S. returns, and the historical yield on bonds has been way higher than it is now… Despite this fact, many financial advisors are still using historical long-term average values in financial plans. I think that’s beyond lazy, it’s almost malfeasance.

Per the findings presented in the epilogue of our SSRN paper, we echo Blanchett’s view on the critical importance of accounting for historic low interest rates when conducting portfolio sustainability analysis for consumers today. However, the fault for failing to make such an accounting lies as much with the software as with the advisors.