SAFT ON WEALTH-Want to follow 4 percent rule? DonGÇÖt start from here: James Saft

Saft@ (James Saft is a Reuters columnist. The opinions expressed are his own)

Aug 16 (Reuters) - If your aim is to spend 4 percent of your portfolio annually in retirement, the best advice is I wouldnt start from here.

Todays high financial asset valuations, with U.S. equity valuations in the 96th percentile, imply we may well be in for an extended period of low returns. That, in turn, ups the chances that a retiree who follows the old 4 percent rule of thumb faces an unacceptably high chance of running out of money before they run out of heartbeats.

Popularized in the 1990s, the '4 percent rule' held that a retiree with a diversified portfolio of stocks and bonds who wants her assets to last 30 years can safely take 4 percent out in the first year and then increase drawdowns annually by inflation.

While the ideal percentage, and the definition of 'safely', have been in hot debate since then, todays heady stock market levels argue for taking a more conservative approach.

Based on market prices compared to the last 10 years of earnings, the S&P 500 now has a price/earnings ratio of about 30, meaning it is trading at a more expensive level than 96.5 percent of all markets since 1871. (https://www.advisorperspectives.com/dshort/updates/2017/08/02/is-the-stock-mark e t - c h e a p )

Valuation is not always destiny, but in aggregate it is an excellent indicator of future returns, with higher prices implying, as a general thing, lower scope for future gains.

Yet, looking at just the top quartile of S&P 500 valuation periods, the following 10 years have seen single-digit or negative annual equity returns 99 percent of the time, according to Goldman Sachs Asset Management. In 17 percent of cases investments at top quartile valuations produce a decade of negative returns. Those kinds of figures put a 4 percent rule plan in serious jeopardy of creating a disastrous outcome. (https://www.gsam.com/content/gsam/us/en/advisors/market-insights/market-strateg y / m a r k e t - k n o w - h o w / 2 0 1 7 / Q 3 2 0 1 7 . h t m l

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High valuations of core assets in the U.S. suggest that retirement withdrawal rates that were once safe may now deliver success rates that are no better - or even worse - than a coin flip, Justin Sibears, of quantitative asset manager Newfound Asset Research writes in a note to clients. (https://blog.thinknewfound.com/2017/08/impact-high-equity-valuations-safe-retir e m e n t - w i t h d r a w a l - r a t e s / ? u t m t s o u r c e = W e e k l y

+ C o m m e n t a r y & u t m t c a m p a i g n = 4 b 0 0 2 e d 1 3 9 - E M A I L t C A M P A I G N t 2 0 1 7 t 0 8 t 0 7 & u t m t m e d i u m = e m a i l & u t m t t e r m = 0 t 2 5 8 a 9 e 8 0 1 d - 4 b 0 0 2 e d 1 3 9 - 3 3 2 9 0 9 9 1 7 )

Retirement success and muted future returns are not mutually exclusive. However, achieving financial goals in such an environment requires careful planning for factors that may have been safely ignored given the generous market tailwinds of prior decades.


Research Affiliates' capital markets assumptions, which notably do not assume a mean reversion of valuations, expect that U.S. equities will over the next decade return 5.3 percent annually in nominal terms, against a historic average of 9 percent. Ten-year Treasuries will return just 3.1 percent annually, compared to 5.3 percent in the past.

Using those figures and running simulations, even a volatile portfolio with 100 percent equities would run out of money before 30 years 34 percent of the time, according to Newfound. A classic 60/40 stock/bond mix would bust 42 percent of the time. But if you cut the initial withdraw level to 3 percent from 4 the picture improves greatly. A 60/40 asset allocation then has a 94 percent chance of not being exhausted in 30 years. Go to 2 percent withdrawal rate and even an all-bond portfolio has a 97 percent chance of lasting.

Those figures, it should be noted, are gross of fees and expenses, which brings us on to our next important set of points.

It isnt so much that you cant get there from here but rather that retirement savers need to redefine both the route and the destination.

For those with a decade or two until retirement, the most obvious and powerful move is to cut current expenses and save more. Plan on retiring later, or on spending less than planned while in retirement.

Many financial intermediaries look at this situation and immediately start to recommend investments they think will beat the market, stressing that this is even more important when market returns will be low. My bias would be towards taking an even more ruthless than usual attitude towards fees and costs.

Annual costs of 1 percent in a 9 percent return world are less significant, proportionally, than in one in which an overall portfolio might only make 4.5 percent for a decade.

Returns are always prospective, to be hoped for but not counted on. Fees and costs are real and certain. (Editing by James Dalgleish) )