How Much Money Do I Need to Retire? by Todd Tresidder

Author:Todd Tresidder
Language: eng
Format: epub
Publisher: FinancialMentor.com
Published: 0101-01-01T00:00:00+00:00

Estimating Your Investment Return Using Valuations

“The only function of economic forecasting is to make astrology look respectable.”

John Kenneth Galbraith

The problem with Monte Carlo and every other type of investment return analysis (except valuation based analysis) is that they provide no useful information for estimating your risk profile and expected return over the critical first 10–15 years of your retirement. That’s what will make or break your financial security in retirement as proven by the research below.

The reason I recommend against using Monte Carlo, backcasting, and average historical return as your basis for expected investment return is because they provide zero understanding about your investment returns over the next 10–15 years (the only returns that actually matter). For example, nobody relying on any of the popular backcasting calculators could have anticipated a high-risk, low-return investment environment in 2000. This was critical information for retirees to know, and only valuation-based models could have provided that information.

That’s why valuation metrics at the beginning of your retirement are a superior modeling tool. It’s the only investment return modeling approach that gives you useful information for your actual retirement time horizon. In fact, Wade Pfau (2010) concludes that retirement success is highly dependent upon early investment returns showing that wealth remaining after 10 years of retirement combined with cumulative inflation during those 10 years explains 80% of the variation in the amount you can safely withdraw from savings.

Michael Kitces demonstrated in this article, using the past 140 years of data, that the safe withdrawal rate for a 30-year retirement is 0.91 correlated to the annualized real investment return over the first 15 years of retirement. This is an astounding number and completely consistent with the research by Pfau, Bernstein, and Easterling cited earlier. The amount you can withdraw from your savings over your entire retirement is related to your first 15 years of investment returns after you retire.

Kitces found that when real investment returns were elevated in the first 15 years of retirement that significantly higher withdrawal rates could be sustained. Conversely, when real returns were depressed for the first 15 years of retirement lower safe withdrawal rates were the likely result. For every instance where the safe withdrawal rate was below 6%, the first 15 years provided a real investment return of just 4% or less.

While you can never know with certainty what the next 10–15 years sequence of returns will be—because nobody can predict the future—multiple resources, including Pfau, Schiller, Easterling, Arnott, Kitces, Hussman, and many more, have demonstrated it’s not random as Monte Carlo and backcasting calculators would assume. There is some order to the chaos over 10–15-year periods and this order is critically important to estimating your investment return and safe withdrawal rate.

Market valuations at the time you begin your investment holding period[15] are inversely correlated to the return you can expect over the following 10–15 years. In fact, Kitces showed the inverse correlation between return and valuation from 1871–2005 was an impressive -0.65. This issue has been well-researched and is

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