What is stagflation?
No growth, sticky inflation,
High unemployment

The Safe Withdrawal Rate (SWR) is an interesting concept. The question it tries to answer is this:

Based on a portfolio’s value, at what rate can I safely draw down my accounts to fund a period of 35+ years without earned income.

Historically, SWR is considered to be 4%. SWR states that you can safely withdraw 4% of your assets in the first year of retirement, then adjust that amount in subsequent years based on the rate of inflation. So, keep in mind that SWR’s 4% Rule applies only in year one. After that, the number increases or decreases.

The 4% Rule presumes the retiree holds a balanced portfolio of 50% stocks and 50% bonds. If the retiree wanted also to grow his or her portfolio rather than simply draw it down every year, William Bengen, who created the 4% rule in 1994, recommended an allocation of 75% stocks and 25% bonds.

In Bengen’s research, he found a portfolio’s longevity was harmed more by owning too few stocks rather than too many. Historically, markets have positive or zero years 75% of the time, with negative years coming only once every four years. For a safe withdrawal rate to keep up with inflation, one needs a healthy allocation to equities.

This leads to the question: assuming a planned percentage of annual withdrawals like the 4% rule, when was the WORST time to retire in American history?

You couldn’t be blamed for thinking the answer is The Great Depression. In fact, you would be correct if your portfolio held more than 75% of its value in stocks. But that’s not what the 4% rule suggests or recommends.

The worst period to retire in American history was April 1965 to January 1966. This period marked the beginning of a prolonged period of one of the most onerous and spooky economic phenomena on earth: stagflation.

Stagflation is defined as a period of little to no growth in Gross Domestic Product; persistent, high inflation; and high unemployment.

There are differing opinions on the actual dates that stagflation officially happened, but it appears to have lasted for 20 years, between 1965-1985. 20 years. Any arguments about what fixed stagflation in the 1980s could be met by the rejoinder that any fix that took 20 years to materialize is no fix at all.

There has been much recent coverage in the media about the Fed raising interest rates and the impact this could have on the economy. Rates are currently at 2.25%, and the Fed has expressed a willingness to push them to 3.25-3.5%.

To give you a sense of how perplexed and panicked our institutions were about stagflation in the 70s, the Fed raised rates to a whopping 19%, triggering not one but two recessions in the process.

If a safe withdrawal rate includes inflation, you can imagine how a 20 year period of high inflation and little to no growth in the economy would demolish a retirement plan. One would have to increase portfolio withdrawals to keep up with rising prices, but that portfolio wouldn’t be able to keep up with those withdrawals. Multiply that by 20 years and you’ve got a recipe for Ray LaMontagne music.

Economists aren’t completely certain as to what causes the combination of conditions that give rise to stagflation. One idea is that shocks to the supply chain will do it. Oil prices surged during the 70s, making necessities like groceries and fuel much more expensive. Those conditions appear to exist now – although not nearly to the extreme of 1970s levels.

The stress on supply chains reduces the amount of goods available and increases production expenses. Both factors increase prices, which increases inflation. The Fed raises interest rates to reduce the supply of money in the economy. This leads to a decrease in the rate of growth in the GDP as the producers of goods and services have less capital to grow their operations.

That leaves high unemployment as the last component of stagflation. As of the time of this writing, the unemployment rate in the United States is historically low. During the mid to late 70s, unemployment climbed to the 7.9 - 9% range. A healthy, or natural, unemployment rate is considered to be 4 - 5%. As of today, August 5, 2022, the unemployment rate in America is 3.5%.

But back to Safe Withdrawal Rates. William Bengen devised the 4% rule in a paper published in 1994, a mere 9 years after stagflation had finally gone to bed. That means his data was skewed heavily towards an economic environment that included the worst 20 year spell in the history of the market.

By comparison, despite this year’s 20% fall in the price of the S&P 500, markets are still priced 53.5% higher than they were at the start of 2019. The S&P was priced at $2,704 at market close on 12/31/2018. As of market close on August 1, 2022, the S&P 500 was priced at $4152.

New ideas about safe withdrawal rates have emerged since 1994. Retirement Guardrails, for example, postulate a sustainable withdrawal rate range, net of taxes and fees (neither of which were variables Bengen considered in his paper), varying between 3-6%. Others tie the safe withdrawal rate to the Schiller PE Ratio, aka the Schiller CAPE Ratio. This adjusts based on the price of the S&P 500 and currently would put a safe withdrawal rate right at 4%.

Retirement income planning is one of the most important and impactful aspects of financial planning for retirees. A University of Chicago study from 1998 showed people with an annuity paying them income for life tended to live longer than people without an income annuity.

My personal view is that this is less about annuities than it is about the emotional attitudes around the certainty of sustainable income. The more certain you are that you can’t outlive your money, the healthier your mental state, which leads to better relationships, better sleep, and potentially longer life.

If the idea of lifetime portfolio withdrawals is making you lose sleep, it might be time for a plan. If you want to explore how an income plan can help you, we’d love to talk to you.