There must be some way out of here
Said the joker to the thief
There’s too much confusion,
I can’t get no relief
Businessmen, they drink my wine
Plowmen dig my earth
None of them along the line
Know what any of it is worth
—Bob Dylan (1967) “All Along the Watchtower”

This is my favorite work by Dylan, who in my mind is the greatest songwriter of his generation. At his peak, in 1967, he wrote one of the most covered rock songs of all time.

The generation of Americans graduating from high school from 1967 to 1969 could have grown up listening to any of today’s pop idols, but through chance and good fortune, they were listening to Dylan at the same time Dylan was writing these masterpieces.

But was the Woodstock Generation so lucky? The graduating classes of 1967-1969 also experienced the largest draft years of the Vietnam War and its largest casualties.

No reason to get excited, the thief, he kindly spoke
There are many here among us who feel that life is but a joke
But you and I, we’ve been through that, and this is not our fate
So let us not talk falsely now, the hour is getting late

Now, for the graduating classes of 1967-1969, the hour is getting late. They have turned 65, or are soon approaching it, and thus many have retired. The same luck or chance that allowed them to experience Dylan—and disproportionately sacrifice in Vietnam—is also dooming their retirement safety.

Just as they are about to stop working, their retirement nest eggs are reaching their largest asset levels. At the same time, the stock and bond markets are at some of the highest levels of the past 145 years, yet are likely to generate returns far below that period’s historical averages.

Wade Pfau, a professor of retirement income at the American College for Financial Services, has developed research on safe withdrawal rates—taking into account the fees for mutual fund management and advisor management and refining the timing risk for people retiring at a specific date. He and I have written about these results in the past two issues of Financial Advisor. Click here to read the "Rethinking Retirement" Whitepaper. Click here to read the October story.

Our research determines that a safe withdrawal rate for the retirement class of 2014, 2015 and perhaps 2016 and 2017 is abysmal. This generation has picked a poor time to retire, no doubt about it.

Their safe retirement rate is 1.7%, assuming they retire on January 1, 2015. We used U.S. 10-year bond yields and stock valuations for the same date. This withdrawal rate is less than 50% of the amount that advisors had used as a common rule of thumb up to this point: the 4% withdrawal rule. That just became the 1.7% withdrawal rule for a 2015 retiree.

Simply stated, either retirees need to have saved twice as much money for retirement as predicted, or they need to spend approximately half of what they thought they would. If they were expecting $1 million to last through their retirement, they really need $2 million. If they believed they could live off $10,000 per month, they need to plan to live off $5,000.

That means this generation, if they are attempting to insure their longevity risk, must get by on less. Their alternative is to accept the very high probability that they will outlive their savings.

Why is this? Chance? Bad timing? Luck of the draw? The sequence of returns?

Well, it is all of the above, but it is especially the sequence of return risk and our ability—with great confidence—to predict that their unique set of early returns will be far below the average of the past century.

That’s because this is one of the worst times to base your retirement on the classic 60% stock and 40% bond portfolio. Stock valuations have been higher in the past 145 years, according to the Shiller cyclically adjusted price-to-earnings (CAPE) ratio, but only on three occasions: in 1929, from 1998 to 2000 and from 2007 to 2008. In those instances, the ratio was over 26x, and each time it presaged three market crashes in the S&P 500. The average of those declines, from peak to trough, was negative 64%.

The Shiller CAPE model is named after Robert Shiller, the Yale University economics professor and 2013 recipient of the Nobel Memorial Prize in Economic Sciences. Also known as “PE10,” this model is commonly used to predict likely equity returns in the 10-to-20-year time period.

The Shiller model currently forecasts returns far below the average in the coming decade, and our unfortunate class of 1967-1969 is looking at equity returns of less than 0.50% per year for the next 10 years. Furthermore, this calculation comes before advisor fees and fund management fees. When those are deducted, Shiller’s model predicts a return of less than negative 1% per year for the coming 10 years.

It gets worse when you turn to bonds. The U.S. 10-year Treasury bond has been at historic highs since 2013 (high bond prices mean low yields). Like current stock valuations, our bond valuations have few historical peers since 1870. In fact, bond prices hit their high in 1946, the only other time in 145 years when the 10-year Treasury yield fell below 2%.



Just as a high relative stock valuation suggests a longer-term low period of stock returns, so it is with bonds. The only precedent, 1946-1956, resulted in total average annual returns of just over 2%, which translates to an after-fee total return of approximately 0.5% on bonds.

So you can see why the current class of new retirees is in such a dire state. Stocks are overvalued, bonds are overvalued,
and people’s retirement is in jeopardy.

A market calamity does the most damage during the early years of a person’s retirement, when his or her accumulated savings are at their peak. And this risk in the sequence of returns can change the outcomes for two portfolios with the same average annual performance. That’s because early negative returns may exhaust a retiree’s funds too quickly for the funds to last the duration of the person’s life.

However, in the classic sequence of return analysis, we are looking at a broad range of outcomes, and the order of returns can vary widely.

Today, we see a profoundly different form of the sequence of return risk for the Woodstock Generation. The twin bond and stock market valuations strongly forecast some nasty potential market outcomes. Today’s risk is not the random difference between time period returns, but the likelihood of far-below-average returns.

A retiree receiving 4% annual withdrawals growing by a 3% cost-of-living adjustment would not erode the principal if his or her average market returns kept pace with his or her withdrawals. There have been periods, such as 1982, when high bond yields and low stock valuations meant withdrawal rates of 7% or 8% were sustainable for 30 years.

If Shiller’s model is correct, and if we use a 60/40 stock/bond combination, the net forecast returns (after fees) could easily be just above zero or just below zero. The withdrawals would leave the portfolio approximately 45% diminished in the first 10 years, depending on the sequence of the predicted returns. After this, there is no real recovery for the retiree. The die is cast.

The sequence of return risk seems to have been written for today’s newly retired individuals. The generation born in the very late 1940s and the very early 1950s are highly likely to experience sustained low or negative market returns in either their last few working years or just after turning 65. If history is a guide, their net returns after fees will be negative or flat for a sustained period.

This is why their actual safe withdrawal rate is so low, below 2% in the most common asset mix recommended for retirement.

There is another bear market we have not mentioned that started in 1966, when the Shiller CAPE ratio was at 24x. This bear market extended to 1974 and incorporated a simultaneous period of steeply rising interest rates that pummeled investors with an annualized return of negative 0.378% for nine years.

To financial advisors, these facts are very difficult to avoid or escape. Bob Dylan, at age 74, probably doesn’t have these retirement fears. However, unfortunately for today’s 65-year-olds, the sequence of return risk may be at one of its highest points of the past
145 years.


Wade Dokken is the founder of WealthVest Marketing. To see the white paper referred to in this article, as well as included footnotes, visit the September 2015 issue at /rethinking-retirement.