Wednesday, December 1, 2010

Will 2000-Era Retirees Experience the Worst Retirement Outcomes in U.S. History? A Progress Report After 10 Years

My hope is to finishing writing three articles before the end-of-year holiday period begins, and now I can say "one down, two to go."

This first article is called "Will 2000-Era Retirees Experience the Worst Retirement Outcomes in U.S. History?  A Progress Report After 10 Years."  The full article can be downloaded from RePEc  or SSRN.  I've submitted it to Journal of Investing, and please keep your fingers crossed about that.

This article is about trying to figure out the impact of the last decade's asset returns on the retirement situation for recent American retirements.  Will 2000-Era Retirees Experience the Worst Retirement Outcomes in U.S. History?  Well, yes, it kind of looks that way.  Let me explain.
There is a popular rule-of-thumb that it is safe to withdraw 4 percent of your assets during the first year of retirement and then adjust this withdrawal amount for inflation in each subsequent year.  But people must understand that the "safe withdrawal rate" rule is based only on retirements beginning up to 1980, because a full 30-years is needed to know how the 4 percent rule fares.  That means we don't know if the 4 percent rule will work for more recent retirees.

Nevertheless, the events of the early part of retirement weigh disproportionately on the final retirement outcome.  I show, in particular, that the wealth remaining 10 years after retirement combined with the cumulative inflation during those 10 years can explain 80 percent of the variation in a retiree's maximum sustainable withdrawal rate from their savings after 30 years.

It has now been 10 full years for anyone who retired at the start of 2000.  And generally, for stock allocations above 50 percent or so, the 2000 retiree has depleted more wealth after 10 years than most any other retiree in history.  That's right.  People who retired at the start of the Great Depression, or just before the stagflation of the 1970s, would still have more wealth after 10 years, and that holds for a variety of assumptions and conditions that are all explained in the paper.  While cumulative inflation has been much less in the 2000s than for retires in the late 1960s or early 1970s, this isn't exactly a source of great optimism.

Whether 2000 retirees ultimately experience the worst outcomes in history and see their safe withdrawal rate fall below 4 percent is yet to be seen.  If the economy starts a prolonged boom in the next couple of years, then 2000 retirees could still be saved.  But the paper shows the required asset returns over the next 20 years for 2000 retirees to maintain positive wealth, and when compared to some reasonable scenarios for expected asset returns, the situation does look kind of grim.  Retirees in 2000, and in the few years before 2000, should really sit down and assess their current situation.  If anyone has been using a real withdrawal rate of around 4 percent or higher, significant reductions in expenditure may be needed.  Please note, I am not a financial planner, and this recommendation is based on the findings of the research paper.