OK, solvent retirement living fans, it’s time for the annual proof of the pudding test of Couch Potato investing. That’s where we dispense with statistics about rates of return and other investment jargon and go straight for the real proof of the pudding — how much money you would have left after (pick a number) years of retirement invested in the simplest, laziest way possible.
To get you in the mood, here’s your spot quiz for the day:
Imagine you retired at the dawn of history, recently estimated as 1988, at age 65. You started your retirement with a $100,000 portfolio split between the total domestic stock market and the total domestic bond market. To pay the bills, you intended to use the 4% spending rule. You took an inflation-adjusted amount at the end of each year.
Question: How much would be left today after 35 years?
Choose one or more answers:
a) After the turn of the millennium internet crash, the financial crash of 2008 and the tech crash of 2022, I’d obviously be broke.
b) I don’t know the dollar amount, but I’m sure it would be less than the cost of breakfast at McDonald’s. We’ve had a lot of inflation in 35 years.
c) Over $700,000.
d) Who cares? Most people are dead at 100 and that’s how old I’d be.
The correct answers are c and d.
Using the indexes alone, with no provision for costs, you’d have $728,880, as figured by the portfolio backtesting tool at portfoliovisualizer.com. Your inflation-adjusted income from the portfolio for the coming year would be $10,319, up significantly from the $4,271 you received at the end of 1988, the first year.
You don’t have to think about the income amount very long to realize that it is less than 1.5% of your ending portfolio. That’s well under the current dividend and interest income from a 50-50 portfolio. So you now have enough money to pay your bills forever if you happen to live that long.
Unfortunately, you’ve probably been dead for quite a while. As a group, all Americans have a life expectancy of 19.2 years at age 65. Only 2.1% of those surviving to 65 will live to age 100. So there’s a 98% probability that your portfolio survived quite nicely. But you didn’t.
Kind of spoils the fun, doesn’t it?
Notwithstanding the being dead part, it’s reassuring to note that 2022 isn’t the first time we’ve had something to worry about when thinking about investments. Back in 1988, we were just exiting the “flash crash” of 1987, worrying about stocks that appeared to be overpriced and concerned about a 4.4% inflation rate that continued rising until it hit 6.1% in 1990.
Worse, we humans were making messes as badly then as we are now. Yes, I know that’s hard to believe. But in 1988, Iraq attacked Kurds with poison gas. A terrorist bomb destroyed a Pan Am jet over Lockerbie, Scotland, killing all on board. The Piper Alpha drilling platform in the North Sea was destroyed by explosions and fires.
Face it, as years go, 1988 wasn’t good for much except the introduction of Prozac.
Does this mean having a simple, dirt-cheap index fund retirement portfolio is a slam dunk?
Sorry, I can’t say that.
A single 35-year period isn’t indisputable proof of investment success because it doesn’t consider a thing called “sequence of returns risk.” That’s the risk that you’ll retire in a time of strongly negative returns. When that happens, it can damage your portfolio beyond recovery.
Think ultimate curses here, like: “May you live in interesting times and may your retirement begin during a period of investment losses.” It’s far better to suffer the negative returns late, not early.
Your 35-year portfolio, for instance, was worth $884,481 at the end of 2021 and declined $155,601 during 2022. That’s a loss greater than its original $100,000 value.
But so what? The portfolio is way larger than expected or needed.
The good news here is that the historical evidence shows, once again, that we can get through some pretty hard times if we keep our investments simple and cheap.
To demonstrate that things go rather well when we embrace simplicity, I’ve run the data for time periods from 35 years to one year. The results are shown in the table below.
Is there a message in these figures?
Yes. It’s a big caution light for recent retirees.
If you retired in the last five years, your current withdrawal rate — 4.7% to 5.3% of portfolio value — is high. And with 30 to 34 years of retirement remaining, that withdrawal rate means that the probability your portfolio will survive is reduced. The portfolio survival probability is between 69% and 85% for living to age 100.
Going broke at 90 or 95 would be awkward.
I found these probabilities using the Monte Carlo analysis tool on the Portfolio Visualizer website. These are probabilities based on historical data. They are not predictions.
Some recent research from Morningstar, however, is encouraging. Its researchers increased their estimated safe withdrawal rate from 3.3% to 3.8% now that equity valuations are lower, and savings earn measurable interest again.
What does all this mean?
First, if you are a recent retiree, don’t make 2023 a splurge year. Do what you can to reduce the amount you spend from your retirement savings, preferably to a bit under 4% of portfolio value.
Second, if inflation recedes and there is some recovery in stock prices, it’s likely 2022 will be no more than a bad memory.
But if inflation continues high and stock prices fall further, we’re in for a sea change in retirement security.