Transcript
Paul Winkler: All right, we’re back here on The Investor Coaching Show. Paul Winkler, along with Ira Work, we’re talking about the world of money and investing.
Is 5% the new 4%?
I saw this article and I thought this was interesting because the 4% rule, if you don’t know what that is, a guy named Bill Bengen did research, using data all the way back to 1900. And he was looking at data on large US stocks. At first, it was just large US stocks and bonds. That was it. And then he added small company stocks later on. He had cash later on, so he had four asset categories.
And then later on, even added more than that and found that, you know, the amount of money you could take out of an investment portfolio and increase it for inflation was about 4% of the portfolio value. You know, so if you had a hundred thousand dollars, you could take out four grand and well, you know, the example I just used, let me just go back to that as million dollars. And I said, if I started in 2000 and I took out $40,000, increased it to $60,000. If I’d done this from a cash portfolio, I’d be out of money. No, because I would have taken out about a million. I put a million in, took out about a million virtually, got no interest almost in the past 20 years. And then, you know, after that, when there nothing left, whereas if I’d done this with a portfolio of 75% stocks, you know, owning large, small, large value, small value, international, large international, small event, all, you know, all asset categories that I talk about in my book, you know, it’s that I would have actually come out with that level of income and the ending value was above what I started with.
So his idea was, Hey, let’s go through all of history and let’s take out 4%, increase it for inflation every year and see where I’d run out of money. And the tough, the part and the time in history that gave him the most pause was 1966 to the 1980s. And it gave him problems because the S&P 500 had zero return after inflation. So you’re having to take out an increasing amount of money every single year, significantly increasing the amount of money, because inflation was so stinky and I, and you know, S&P didn’t do that well during that period of time, then you had the oil crisis years and all that stuff that happened.
Reagan just didn’t come fast enough is really what happened. Then he tried doing this with small company stocks and he actually increased it 4.6%. Now that was, you know, one of the things that he did when he added another asset category. So it was actually able to increase it a little bit. I tend to be more conservative when I talk about this, I just use the 4% rule. Now he was able to increase it a little bit more when he added more asset categories, but, you know, I still kind of harken back to the 4% rule. Well, he said in this article. The 4% rule is a safe withdrawal rate for retirement savings. And the discussion, the retired advisor said, he’d actually use 4.5% for his clients.
In fact, with inflation as low as it is today, he says the safe withdrawal rate may be closer to 5%. So I thought it was interesting when I saw the headline of the article, “Father of 4% rule says it was more of a guideline.” I’ve heard so many people try to question, and the reason is because they want to show the annuities. That’s true. And also they didn’t follow the dictates of the role and, and what the, what he said you had to do to get this to work.
Ira Work: Well, it makes more sense if you want to sell annuities and make 8% commission to say the 4% rule doesn’t work with a diverse portfolio.
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Past Performance Isn’t Everything
Paul Winkler: Oh yeah. And it didn’t work the way they manage money because they used active management stock picking market timing, tactical asset allocation. Now they just broke every rule. And that’s not what was in Bill Bennigan’s original study. That is not what he did. You know, so it’s, it’s interesting, you know, when they said it didn’t work and you know, the reason it primarily because they didn’t follow the, the, and one of the big reasons they didn’t do it is because past performance was how investment vehicles were chosen and have been chosen for decades by the investment industry. And if you look at the past 20 years, you get that that’s a hard period to have followed the 4% rule and make it work because you started the 20-year period with a three-year market downturn.
Now it wasn’t down for every asset category, but remember, that’s not what the investment industry does. They don’t tend to diversify very well. They tend to focus mainly on big US companies, the darlings, the recognizable companies, you know, and that’s what people are doing right now. It’s just, you don’t have the same exact thing.
Ira Work: Even when you’re using historical rates of return, they’re typically using short term, they’re not using real historical. Like when we use historical rates of return, we’re going back to 1973 or 1926.
Paul Winkler: Colin bangin and went back to 1900. Right. You know, he went way back and, you know, and it’s just interesting to look at stock pricing right now. And some people will ask me, “Well, Paul, does it even make sense to use that old data and go back all the way to that period of time?” And I’ll say, “Yeah, you know why? Because stock prices are very similar or right in the normal range to day to day as we speak.” And literally you, when people say, well, the market’s high, you know, the, the S&P is high, you know, and I’ll look at it. I go, Yeah, it’s a little higher than normal, but it’s not anywhere higher than it hasn’t been in many periods throughout history.
You know, you have periods of time all the way in the past hundred years where it’s been much higher compared to earnings than it is right now. And still that 4% rule worked, you know, in those periods of time. Now, there are lots of areas of the market that are way the heck lower than historic norms right now, too. But, you know, we’re just talking about a couple of areas in the market right here. And I think it’s just interesting. Why did he say that the withdrawal rate could be higher because inflation is so low. Remember what this assumes, when you’re doing this 4% rule, you’re not just starting at 4% and leaving it there, you know, on my million dollar portfolio, you didn’t start with $40,000 and take out 40 and 40 and 40 and 40 and 40 and 40, like an annuity.
Inflation Really Happens
Would you increase it for inflation every single year? So it went from 40 to 41 to 42 to 43 to 44 to 45, 46 had no idea. And you know, now it’d be 60, 20 years later. And it’s, you know, people, it’s hard to believe that, you know, inflation has caused a 50% increase in prices over 20 years, but it has. And you know, you look at that and go, well, shoot, why is that so surprising? You could buy a house in the 1970s for $30,000, and now it’s $300,000. Why does this surprise you that we’ve had a 50% increase in 20 years when we’ve had a tenfold increase in why so much more time value of money?
Number one, you know, time you look at compounding Einstein, didn’t say the compounding was the one end of the world for nothing. That’s right. That’s right. Pretty smart guy. Oh, well, you know, so anyway, so I think it’s just interesting. So if you look at that and say, well, you know, if we do have continuing low inflation, can you actually take out a little bit more basically, because he was using 30 years of data, you know. Remember he was using a 30-year period and you look at that and go, okay.
So, you know, if I had gone all the way through history, taken out a 4% distribution, increased it for inflation. And I had 30-year, every 30 year period in all of history would, I’ve been with that have been a workable amount of money. And he used, it was 50% equities, 50% of stocks minimum up to like 75% stocks. You know, he tried all different types of asset mixes. He found that was optimal. Those areas right there, if you want to know that. And then what he did is he wanted to see, you know, would I have actually run out of money in that period of time? And, and the answer was, that’s where the number came from. It was because you wouldn’t have run out of money. So it’s just interesting to see that because of higher or lower and excuse me, lower inflation rates right now, you can take out higher distributions and, you know, in, and do you do that?
I just, I tend to be fairly conservative. You know, I tend not to, you know, increase distributions too much, but you know, the reality of it is something else. How do we actually operate this? With my clients, I’ll go, you know, let’s do this, let’s take a distribution lesson, let’s look at it each year. And judge it based on, you know, how things are going. I have some people that will just go based on requirements and distributions, which I think is nice because you’re changing your distribution. And it’s based on whatever you have in the portfolio. And you’re taking out a set percentage of the portfolio, which increases a little bit each year, but it’s a set percentage of whatever you happen to be there.
And you don’t run out of the portfolio at all when you do that. And that’s something that I think is really, really a helpful way of handling knowledge. What’s interesting with the new table, it’ll still have money at 120. If you lived out alone, 120, 120, well, are you going to be around 120? I don’t know, listening to The Investor Coaching Show. And I’m your host, Paul Winkler. We’ll see you next time.
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