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 would you have left after (pick a number) years of retirement invested in the simplest, laziest way possible.
Retiring at the Dawn of History, 1988
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 percent 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 answer:
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).
A surprising, big number
Using the indexes alone, with no provision for costs, you’d have $728,880, as figured by the portfolio backtesting tool at www.portfoliovisualizer.com. Your inflation-adjusted income 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 percent 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.
You’re set.
When your portfolio survives but you don’t
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 percent of those surviving to 65 will live to age 100. So, there’s a 98 percent 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 percent inflation rate that continued rising until it hit 6.1 percent in 1990.
Yes, humans were in turmoil back in 1988, too
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 total slam dunk?
Sorry, I can’t say that.
Sequence of returns risk
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 the 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.
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| The 2022 Pudding Report: What’s Left After Years of Withdrawals | ||||
| This table shows the amount left after periods of one to 35 years in a portfolio of $100,000 invested 50/50 domestic stocks/bonds when an annual inflation adjusted amount of $4,000 is withdrawn at the end of each year. It assumes investment in asset classes and does not allow for the costs of investing in indexed mutual funds or exchange-traded index funds. This is a hypothetical investment. Vanguard Total Stock Market Fund didn’t exist until 1992. Vanguard Total Bond Market fund didn’t exist until late 2001. Since inception, the cost of these and other index funds has come down dramatically. It can now be done for 0.03 percent a year. | ||||
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Age/Years Begin End End End Inc as%
Invested Year Value Income End Value
100/35 1988 $728,880 $10,319 1.4%
95/30 1993 $375,670 $ 8,392 2.2%
90/25 1998 $163,386 $ 7,383 4.5%
85/20 2003 $188,126 $ 6,583 3.5%
80/15 2008 $133,075 $ 5,670 4.3%
75/10 2013 $135,681 $ 5,187 3.8%
70/5 2018 $102,150 $ 4,831 4.7%
68/3 2020 $94,796 $ 4,634 4.9%
66/1 2022 $79,303 $ 4,271 5.3%
Source: www.portfoliovisualizer.com
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Is there a message in these figures?
A caution light goes on
Yes. It’s a big caution light for recent retirees.
If you retired in the last five years, your current withdrawal rate –4.7 percent to 5.3 percent of portfolio value – is high. And with 30 to 34 years of retirement remaining, that withdrawal rate means the probability your portfolio will survive is reduced. The portfolio survival probability is between 69 and 85 percent 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 encouraging research at Morningstar
Some recent research from Morningstar, however, is encouraging. Its researchers increased their estimated safe withdrawal rate from 3.3 percent to 3.8 percent now that equity valuations are lower, and savings earn measurable interest again.
What does all this mean?
What to watch for
Two things.
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 percent 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.
Stay tuned.
Related columns:
Scott Burns, Pudding Reports for 2020, 2021: https://scottburns.com/?s=Pudding
Scott Burns, “How I became a Couch Potato Investor, 9/25/2018: https://scottburns.com/how-i-became-a-couch-potato-investor/
Sources and References:
Portfolio Visualizer website, Asset Allocation Portfolio Backtest tool: https://www.portfoliovisualizer.com/backtest-asset-class-allocation
Portfolio Visualizer website, Monte Carlo Simulation Tool:
https://www.portfoliovisualizer.com/monte-carlo-simulation
National Vital Statistics Reports, Vol 71, Number 1: United States Life Tables, 2020, 8/8/ 2022: https://www.cdc.gov/nchs/data/nvsr/nvsr71/nvsr71-01.pdf
Events of 1988: https://www.thepeoplehistory.com/1988.html
Christine Benz, John Rekenthaler, “What’s a Safe Withdrawal Rate Today?” 12/13/2022: https://www.morningstar.com/articles/1128840/whats-a-safe-withdrawal-rate-today
Morningstar report on Vanguard Balanced Index Admiral shares: https://www.morningstar.com/funds/xnas/vbiax/quote
Morningstar report on Vanguard Total Stock Market Index ETF: https://www.morningstar.com/etfs/arcx/vti/performance
Morningstar report on Vanguard Total Bond Index ETF: https://www.morningstar.com/etfs/xnas/bnd/performance
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
(c) Scott Burns, 2023
7 thoughts on “The Pudding Report, 2022 ”
Comments are closed.
After being a firm disciple of couch-potato investing for about 30 years, it was clear that it needed to be abandoned with the actions of the Fed and increased inflation. I did so, and am glad I did. Short term treasury ladders were my fall back. That being said, once things look more favorable, I will gladly go back to the couch.
Congratulations, you moved out of harms way and lost less than a Couch Potato who held fast. I don’t think, however, that makes the Couch Potato portfolio a failure. While it had one bad year, ranking below about 80 percent of balanced funds, it generally performs in the top 20 to 40 percent in individual years and improves as the measuring period is lengthened.
The caution light is on because that one year lowered the portfolio value enough to make the scheduled withdrawal a higher than comfortable percentage of the portfolio.
That said, you have to ask where all the other alternatives were. Many are offered, usually with large, confident fees. But they seldom offer an improvement on simplicity.
Anecdotally, I’ve heard that most investors who try to time the market have to be right twice. Mr. Crockett has only solved 1/2 of the market-timing strategy. He will not have accomplished much if he re-enters the stock market too late in the recovery and buys back in at a higher price than when he sold.
Great point, Curtis! Market timing requires being right twice. Once when you sell. Again when you buy. In my experience, it’s pretty easy to talk yourself out of owning stocks but those that do seldom, if ever, find the right time to buy back in.
I must be missing the complete picture in the example scenario. It reads as if a 4% withdrawal on $100,000 provides sufficient funds to meet all financial needs (“to pay your bills forever”). Of course, one could add in Social Security. The scenario assumes age 65 so Social Security would have to be started earlier than age 70. If the only source of funds was Social Security + the $4,000/year amount taken from investments, I just do not see how this is illustrating a comfortable retirement. What am I missing here?
I think you are missing that it is an illustration, not a case study. The subject is whether a simple, low cost index fund portfolio can survive long periods of time with regular withdrawals that provide constant, inflation adjusted purchasing power. If I had used a $1 million portfolio as a starting value an abundance of readers would have complained that I was just writing for rich people and the example wasn’t real world.
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