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.
The Times Are A-Changing Your Retirement
November 2, 2015
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Comments
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60/40? Really? Who in their right mind puts 40% of anyone's money in bonds (and I wager your model uses long term Treasury bonds), when interest rates are near 35-year lows? 60/40 is so "Wall Street" passé. My gosh, it's not at all difficult to find better value, higher-yielding assets than 30-year government bonds these days, and assets that have some growth as well as growth of income potential. Small pieces of dividend aristocrats, energy MLPs and short duration bonds come to mind right off the bat. I'd also urge advisors to utilize inflation hedge tactics by using select asset classes that will likely benefit from the coming debt-bomb explosion. The academes of the world, along with political correctness, will surely become our downfall.
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The key to avoiding sequence risk is owning a large liquid asset which buffers against poor equity and bond returns, and also provides an income stream for years to come. Many of my clients own large cash value life insurance programs with hundreds of thousands of dollars in their cash values-some more than a million. These more mature policy cash values currently earn 4-5% tax deferred, with no risk of principal. The cash values also act as an emergency fund-so instead of Money Market cash, or short term bonds earning essentially zero, we capture 4-5% through cash value life insurance. Moreover, when we layer on lifetime annuity income which cannot be outlived, we mitigate sequence risk, and also accrue mortality credits along the way-meaning higher income downstream. No other asset class or product is capable of providing mortality credits. None. Mortality credits are unique to the annuity income strategy. And, if the lifetime annuity is also eligible for dividends via a mutual company, these dividends provide enhanced income, and, also help mitigate inflation risk. The annuity income also avoids advisory fee risk, along with elderly decision-making risk. Owning myriad streams of guaranteed monthly income-called "flooring", in addition to a robust equity portfolio, and hundreds of thousands of dollars in life insurance cash values, provide the optimal confluence of unique asset classes designed to provide enhanced Retirement Plan (RP) success probability. The higher the guaranteed lifetime income floor? The less pressure on equity portfolio performance to provide basic necessity income. And, when a retiree passes away leaving just a widow(er)? The life insurance death benefit replaces a lost SS check. Providing further income security in retirement. AUM advisors may not appreciate this truly client focused RP approach, however, it certainly is successful when properly implemented.
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Saying that this is a bad time to retire implies that those who are already retired are home free. Those just retiring and those already retired, all are just beginning the start of the rest of their retirement. That means that all retirees must deal with all of the adverse issues mentioned, except maybe those already age 100+. Sequence of returns is only an issue if the distribution rate is based on current portfolio value without adjusting the value to account for current over-valuation and current return expectations.