Roaring inflation and rising interest rates aren’t great news for retirees and near-retirees. But there is less to worry about in today’s economy than they might think.
The current threats are minor compared with the disaster that was the 1970s, when inflation regularly hit double digits and North American economies staggered under the blows of repeated energy crises.
Retirement rules developed to withstand shocks of that magnitude should weather today’s turbulence just fine, experts say.
“I was much more concerned a couple of years ago, when the pandemic hit, than I am now,” Wade Pfau, a professor of retirement income at the American College of Financial Services in Philadelphia, said in an interview.
Mr. Pfau, a leading researcher in retirement finances, points out that long-term bond yields are still relatively low in both Canada and the United States, a sign that market professionals think central banks are still firmly in control of long-run inflation. Policy makers will no doubt hike interest rates in coming months to tamp down price pressures, but there is no sign in the market that today’s red-hot inflation readings are destined to become permanent, he said.
Unlike a truly rare disaster such as a global pandemic, the current inflationary outburst resembles a muted replay of the 1970s – and retirement planners have long used strategies designed to soldier through such episodes.
Consider the 4-per-cent rule. First articulated by financial adviser William Bengen in 1994, it holds that a retiree planning for a 30-year retirement can safely withdraw an inflation-adjusted 4 per cent of their starting portfolio each year without fear of running out of money.
To develop the 4-per-cent rule, Mr. Bengen looked at the withdrawal levels that would have worked in the past. He considered the case of a U.S. retiree with a portfolio split evenly between bonds and stocks, and found that someone who stuck to a withdrawal rate of 4 per cent or less could have slogged through the Great Depression, the Second World War or the 1970s stagflation without running out of money.
More recent research has suggested a slightly lower withdrawal rate might be even safer. A report last year from investment researcher Morningstar argued that a dependable withdrawal rate is now more like 3.3 per cent – a reflection of how low bond yields have fallen. But it also found that making some simple changes – adopting a more flexible attitude toward spending, for instance – could boost the starting withdrawal rate to as high as 4.5 per cent.
This largely jibes with the findings of Karsten Jeske, an economist who retired in his early 40s after a career as a Federal Reserve researcher and Wall Street strategist. He writes the Early Retirement Now blog, an invaluable source of information for anyone with a taste for numbers and a desire to escape from the work force.
In a post last month, Mr. Jeske considered the question of whether high inflation affects retirement strategies. His conclusion? It really doesn’t. Looking back at 30-year periods from 1920 onward, he found no strong relationship between prevailing levels of inflation and future safe withdrawal rates.
What matters far more, he found, is stock valuations. When stocks are expensive compared with their long-run earnings – as they are now – retirees should be cautious about how much they withdraw from their portfolio because high valuations are usually a sign of lower stock-market returns to come.
Right now, he writes, “we should certainly be worried about the future and choose a conservative, safe withdrawal rate. But that has nothing to do with inflation and has everything to do with lofty equity valuations.”
While the exact number for each person will vary depending on a number of factors, he concludes that a safe withdrawal rate in today’s environment for someone beginning retirement is “certainly below 4 per cent but not really that much below 4 per cent.” His calculations suggest a 3.5-per-cent withdrawal rate should stand up to any likely scenario to come.
To be sure, there is always the remote possibility that everything bad will happen and happen together. Want even more reassurance? One simple strategy is to reduce your spending if the stock market tumbles, says Mr. Pfau at American College. He says a commitment to cut your spending by 15 per cent during market downturns can substantially increase the sustainability of your retirement portfolio and allow for a slightly higher withdrawal rate during good times.
But he isn’t all that worried about what is to come. Anyone who sticks to a reasonable withdrawal plan and maintains a diversified portfolio doesn’t have to fear the future, he says. “There is nothing here we haven’t seen before.”
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