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.

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