February 1st 2024.
Recently, I had the pleasure of reading a thought-provoking book by Antti Ilmanen titled "Investing Amid Low Expected Returns." In this book, Ilmanen shares his insights on the current state of the stock market, bond market, and other assets, all of which are expected to yield low real returns in the future. This raises some interesting questions, especially for retirees, such as how much they can safely withdraw from their investments if these low returns continue. Historically, stocks have averaged a return of around 7%, but in the future, we may only see returns of 3-3.5%. This poses a challenge for those relying on their investments for retirement income.
The issue at hand is that we cannot rely solely on historical data to determine a safe withdrawal rate in this new environment. We can only look at two instances in history where investors faced similar circumstances: before the stock market crash of 1929 and before the dot-com bubble burst in the late 1990s. However, these two examples are not enough to make a generalization. While the 1929 scenario may have resulted in a failure for those who withdrew 4% from an all-stock portfolio, we cannot yet determine the outcome for those who retired around 1999-2000, as we do not have a full thirty years of data.
To address this issue, I propose using a Monte Carlo simulation instead of relying on historical data. This simulation would calculate safe withdrawal rates based on the expected mean return and standard deviation of the investment portfolio. This approach only requires two pieces of data, making it a simpler and more efficient way to determine a safe withdrawal rate in a low-return environment.
Fortunately, I have created a spreadsheet called the Red Portfolio Black Portfolio that can perform this Monte Carlo simulation. You can download a free copy of this spreadsheet and follow these steps: first, enter your starting balance in cell B4, then enter a negative value in cell B5 to show the probable starting withdrawal amount. Next, specify the percentage increase in the draw using cell B6. Finally, enter the standard deviation and arithmetic mean return for your primary "Red" portfolio in cells B8 and B9, respectively. As a benchmark, the spreadsheet uses a "Black" portfolio with a standard deviation of 6% and an arithmetic mean return of 5.4%, which I believe represents a portfolio of 100% Treasury Inflation Protected Securities.
On a side note, I suggest using whole percentages in this simulation to stay focused on the purpose of learning rather than conducting formal research. For example, using 11% and 6% for the standard deviations of the Red and Black portfolios, and 6% and 5% for their arithmetic means, serves as a simple reminder of the simulation's purpose.
Now, let's discuss how to interpret the results of this Monte Carlo simulation. The line chart shows the probable safe withdrawal rates for various lengths of retirement based on the specified starting balance and withdrawal amounts. This chart can provide valuable insights into the safe withdrawal rates in a low-return environment, and I highly recommend using it to guide your retirement planning decisions.
In conclusion, the current state of the market raises many questions, and we must adapt to this new environment to ensure our financial security during retirement. The Monte Carlo simulation offers a practical and efficient way to determine safe withdrawal rates in these circumstances, and the Red Portfolio Black Portfolio spreadsheet makes it incredibly easy to perform this simulation. I hope this tool will assist you in making informed decisions about your retirement planning.
Recently, I read Antti Ilmanen's book, "Investing Amid Low Expected Returns," and it really got me thinking. Like many other experts, Ilmanen predicts that stock and bond returns will be significantly lower in the future. This raises some important questions, especially for retirees. How much can we safely withdraw from our investments if we can only expect a real return of around half of what we've seen in the past? For example, instead of the usual 7% return on stocks, we may only see 3-3.5%.
This is a challenging issue, and one that is not easy to answer. The main reason being that we don't have enough historical data to accurately model safe withdrawal strategies in a low-return environment. There are only two notable instances where we can look at low return scenarios: the lead up to Black Tuesday in 1929 and the dot-com crash in the late 1990s. However, these two examples are not enough to make generalizations from.
For instance, it is believed that a 100% stock portfolio starting in 1929 and withdrawing 4% would have failed. As for those who retired in 1999 or 2000, we still don't have enough data to determine if their retirement plan was successful or not. This is where the idea of using a Monte Carlo simulation comes in. Instead of relying on historical data, we can use this simulation to calculate safe withdrawal rates based on the expected mean return and standard deviation.
The beauty of this approach is that we only need two pieces of data - the expected mean return and the standard deviation. With these, we can get an idea of how much we can withdraw in a worst-case scenario in a low-return environment. Fortunately, there is a handy spreadsheet called the Red Portfolio Black Portfolio that allows us to do just that. You can download a free copy of this spreadsheet and follow a few simple steps to determine your safe withdrawal rate.
First, input your starting balance in cell B4. Then, enter a negative value in cell B5 to see the probable starting withdrawal amount. You can also specify the percentage increase in the draw using cell B6. Next, enter the standard deviation for your primary "Red" portfolio in cell B8 and the expected mean return in cell B9. For example, a balanced portfolio with 70% stocks and 30% bonds may have an expected mean return of 6.2% and a standard deviation of 11.3%. For comparison, the "Black" portfolio represents a 100% Treasury Inflation Protected Securities portfolio, with a standard deviation of 6% and an expected mean return of 5.4%.
It's worth noting that for the purpose of this simulation, it's best to use rounded whole percentages, such as 11% for the Red Portfolio's standard deviation and 6% for the Black Portfolio's. This serves as a reminder that this is a learning exercise and not a rigorous academic study. Finally, the spreadsheet also includes a line chart that helps interpret the Monte Carlo safe withdrawal rates. This chart can give you a better understanding of how various withdrawal rates may fare in a low-expected-return environment.
In conclusion, while it may be challenging to determine safe withdrawal rates in a low-return environment, the Monte Carlo simulation provides a useful tool to help us plan for retirement. By using the Red Portfolio Black Portfolio spreadsheet, we can get a better understanding of how much we can safely withdraw in different scenarios. However, it's important to remember that this is not a perfect solution and should be used as a guide rather than a definitive answer.
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