There’s a whiff of 1968 in the air. China’s “
U.S. consumer inflation has risen to a four-decade
The post-crisis period has been kind to asset owners, including retirees. Near-zero interest rates have propelled an almost ninefold total return in the S&P 500 stock index (including reinvested dividends) since the bottom in 2009 and buoyed bond values. While that has fattened investment portfolios, conditions for those projecting returns forward into the future are now radically different. Inflation is quickening just as stock valuations — as measured by the
The world was a simpler place the last time serious inflation took hold in the global economy. Fifty years ago, pensions were typically defined-benefit plans that paid employees a multiple of their final salary, indexed to inflation. In the past few decades, these have largely been replaced by defined-contribution plans that shift investment risk to the recipient. This set off a hunt to determine the percentage that retirees could safely withdraw from their pension pot each year without ever running out of money. That figure was put at 4% in a widely followed rule-of-thumb proposed in 1994.
Subsequent research suggested that retirees could take a more liberal approach, depending on their tolerance for risk. In a 2011
That’s without factoring in inflation, though. Adjusting withdrawal rates to keep the real purchasing power constant, the chances of running out of money jump. The success rate for the same 50-50 portfolio and 7% annual withdrawals drops to 22% for a 30-year retirement period. For a 4% withdrawal rate, that rises to 96%.
The Trinity research uses data over rolling periods from 1926 to 2009 — encompassing seismic periods such as the Great Depression and the global financial crisis — so its empirical basis is robust. However, after three decades of quiescent inflation during which cost-of-living adjustments haven’t forced major changes to underlying assumptions, we may be on the verge of unprecedented financial regime change. Never before have we entered an inflationary period with equity valuations so extreme. Only once has the CAPE been as high as it is today: During the internet bubble in 1999-2000.
The current environment is “off the charts,” and it’s impossible to tell what the safe withdrawal rate would be from here, William Bengen, the retired financial advisor who developed the 4% rule (which he subsequently revised up to 4.7% after adding other asset classes), said on Morningstar’s
The good news is that the 4% rule should always hold up, if history is a guide. Bengen has said that this was a