Insight -Retiring early to lie flat? Keep an eye on inflation


Perilous times: A customer shopping for groceries in a Manhattan store in New York City. How high inflation will go, and how entrenched it will become, are critical questions for retirees. — AFP

THERE’S a whiff of 1968 in the air.

China’s “lying flat” movement has more than a passing echo of the US counterculture of the 1960s, and has found resonance around the world.

It isn’t only the young and disaffected who are choosing to drop out.

Two years into a global pandemic, the number of Americans choosing to retire early has been surging. It’s a perilous moment for them.

US consumer inflation has risen to a four-decade high of 7%.

The increase in prices has been so broad and sustained that we are already beyond the point where it can be considered a transitory phenomenon resulting from Covid-19 disruptions.

How high inflation will go, and how entrenched it will become, are critical questions for retirees.

If the trend is here to stay, it may upend assumptions that have prevailed for decades.

The post-crisis period has been kind to asset owners, including retirees.

Near-zero interest rates have propelled an almost nine-fold 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 cyclically adjusted price-earnings ratio, or CAPE, developed by Yale University’s Robert Shiller – are close to their highest ever.

That’s the worst possible combination for retirees planning to live off their investments.

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In the past few decades, these have largely been replaced by defined-contribution plans that shift investment risk to the recipient.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 study, researchers at Trinity University in Texas presented actuarial tables showing portfolio survival rates for different mixes of stocks and bonds over periods varying between 15 years and 30 years.

They found that portfolios containing at least 50% equities could support withdrawal rates of up to 7% with a high probability of success (meaning there was a positive terminal value at the end of the retirement period).

For example, a portfolio with a 50-50 split and 7% annual withdrawals had an 85% chance of lasting 30 years.

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.

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 adviser who developed the 4% rule (which he subsequently revised up to 4.7% after adding other asset classes), said on Morningstar Inc’s The Long View podcast last month.

For Americans deciding this is a good time to leave the workforce, Bengen had bad news.

“Early retirement is particularly dangerous,” he said.

Spending too much too soon is the danger, with the first five to seven years setting the tone for the whole retirement period.The good news is that the 4% rule should always hold up, if history is a guide.

Bengen has said that this was a worst-case scenario based on someone who retired at the most unfortunate moment (until now, at any rate), just when the stock market peaked and inflation was starting to spin out of control: in October 1968.

So, by all means drop out, kick back and put “Hey Jude” or “I Heard It Through the Grapevine” on the turntable. Just don’t go wild with your spending. Yet. — Bloomberg

Matthew Brooker is a columnist and editor with Bloomberg Opinion. The views expressed here are the writer’s own.

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