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3% is the new 4% for Retirement Planning

3% is the new 4% for Retirement Planning

In retirement planning, a 4% safe withdrawal rate (SWR) has been considered the standard for many years. Introduced by the Trinity Study1 in 1998, the study states that investors can safely withdraw 4% of their portfolio annually in retirement, with a very low probability of running out of money. For example, an investor with annual expenses of $100,000 would aim to save $2.5mn for retirement. However, the Trinity Study focused on the 1925-1995 time period when interest rates were much higher than they are today, equity multiples were mostly lower than they are currently and life expectancies were shorter. As a result a 4% SWR is too aggressive for long-term planning given current market conditions. Let’s dive in to some of the changes since the study was conducted.

For the 1925-1995 period, the yield on the 10Yr. US Treasury averaged 5.17% compared to only 0.73% as of April 9th, 20202. In fact, the 10Yr. Treasury hit an all-time low of 0.32% on March 8th.

interest ratesSource: Robert Shiller data

As a result, you should expect to earn much less income from a bond portfolio compared to the recent past. The low interest rate environment in the U.S. is largely driven by expectations for weaker inflation and weaker real GDP growth over time. In the U.S., the Federal Reserve has largely failed to hit its 2% inflation target since the Financial Crisis. In fact, market participants believe inflation in the U.S. will stay around 1% over the next decade with 10-year TIP's break-evens at 1.23%. 


GDP growth is driven by two factors: population growth and labor force productivity, which measures how much output is produced per hour of work. Economists expect U.S. real GDP growth to be in the 1-2% range going forward as the aging U.S. population and declining birth rates will lead to lower increase in the number of hours worked. Unless immigration increases substantially, unlikely given the current presidential administration, U.S. population growth will remain weak for years to come. The other key driver of GDP growth, labor force productivity, has also been weak following the Great Financial Crisis, and contributes to weaker GDP growth forecasts. 

productivitySource: BLS

In terms of U.S. equity valuations, P/E multiples for the S&P 500 Index are at high levels compared to history. The trailing P/E multiple on the S&P 500 averaged 14.2x from 1925-1995 compared to roughly 21x today, meaning that the S&P 500 is 48% more expensive than during the period highlighted in the Trinity Study. By another metric, the Shiller Cyclically Adjusted P/E (CAPE) ratio, the S&P 500 is in the 77th percentile in terms of most expensive since 1925. Unfortunately, this means that equity returns are likely to be lower going forward going forward as equity multiples tend to mean revert over time. Check out the asset class primer on Equities to learn more about expected returns for stocks going forward. 

p e ratioSource: Robert Shiller data

Finally, average life expectancy in the U.S has increased by 3 years since 1995, from 76 to 79 years and by 11 years since 1950. A longer life expectancy means you should plan for a longer retirement today compared to the time period studied during the Trinity Study.3

As a result of low interest rates, high p/e multiples and increased life expectancy, you should consider a SWR lower than 4% to be appropriate in today’s environment. In fact a SWR of 3% will likely become the norm. This means that an investor with annual expenses of $100,000 would need a portfolio of $3.33 million, compared to a $2.5 million portfolio using a 4% SWR. Of course, there are a variety of factors for you to consider in determining your SWR, including your expected retirement age, estimated pension and social security income and other income streams you may have such as real estate investments. Personal Finance blogger Big ERN has written extensively on SWR’s and I strongly recommend you check out his informative series on the topic. https://earlyretirementnow.com/safe-withdrawal-rate-series/ Check out our asset allocation recommendations and asset class primer to learn more about investing and how you should be investing based on the number of years until you plan to retire. In our next blog post we’ll discuss strategies you can use to in this challenging investment environment. 

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  1. See here for more information on the Trinity Study: https://en.wikipedia.org/wiki/Trinity_study
  2. Robert Shiller has a trove of market data publicly available here: http://www.econ.yale.edu/~shiller/data.htm
  3. https://www.macrotrends.net/countries/USA/united-states/life-expectancy

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