“What Bill Bengen did was an ingenious start, but when you dig deep you’ll find that retirement doesn’t really work that way. I became convinced that it was the right way to start, we just needed to make it better.”
The timing of a person’s retirement has as much to do with his or her potential retirement success or failure as the estimated withdrawal rate, he says. In most situations, market performance decides whether someone’s retirement income plan will be successful or not, and market performance is unpredictable—to a point.
Illustrating the Problem
In a case study, LaBrie looked at hypothetical retirees leaving the workforce in the early to mid-1970s, right around the time of a major decline in U.S. equities. He looked at three hypothetical retirees, each with $100,000 in all-equity portfolios but with different retirement dates.
If a hypothetical retiree named Anita had left work in August 1973, assuming she had paid 2 percent in investment and advisory costs and taken 4 percent in retirement withdrawals, her $100,000 portfolio should have lasted the duration of her retirement. But if another client, Bob, had retired seven months earlier in February of 1973 with the same portfolio and following the same rules for withdrawals and expenses, he would have started to run out of money when equity markets declined in the mid-’70s.
On the other hand, if Charlie, our third example, had waited until October 1974, 14 months after Anita retired, using the same portfolio and the same expenses and withdrawals, he would have seen his portfolio grow to $1.2 million—12 times its size at his retirement date.
LaBrie conducted another case study of retirees around the October 1929 market crashes using two hypothetical investors, Jim and Euclid. If Jim and Euclid both inherited $100,000 in September 1929 and invested it all in equities, their outcomes would have depended on their retirement date. If Jim started taking withdrawals from his $100,000 immediately, his portfolio value would have dropped to less than $14,000 by June 1932 and would have been completely depleted by the time the U.S. became involved in World War 2. If Euclid decided to wait to take withdrawals until June 1932, his portfolio would have still taken a huge hit from the market crash and malaise of the Great Depression—its value would have been only $23,000 by the time he started taking withdrawals—but the recovery during and after World War 2 would have sent his portfolio into exponential growth, suggesting he could have sustained a higher withdrawal rate.
Central to LaBrie’s method is the idea that a portfolio’s price at market in real time does not reflect the real “internal” value of its constituent investments. Market prices fluctuate around the real internal value of a portfolio; the internal value represents a mean that prices inevitably revert toward. The difference between the market price and internal value of a portfolio creates a value gap that retirement planners should account for.
“What we’re seeing is the same problem over and over again; it’s incredibly consistent,” says LaBrie. “I have data going back to 1801—you can take any 20- to 30-year period in history; going back that far you have 1,356 unique 30-year periods and come up with the same analysis. We have a huge accuracy problem.”
LaBrie charts a regression of real total U.S. equity returns on a logarithmic scale, also charting the mean historical real return of $1 invested in 1801 on the same graph. The total return of the S&P 500 dances above and below the mean historical real return over time.