# Retirement in a High-Inflation Environment – SWR Series Part 51

*February 28, 2022*

What a difference a year makes! In late 2020, only about 16 months ago, I felt the urge to comment on the then-fashionable discussion of how **low inflation** would impact retirees. See Part 41 – Can we raise our Safe Withdrawal Rate when inflation is low? of my SWR Series. Feels like a lifetime ago, doesn’t it?

The takeaway back then: don’t get distracted by high-frequency economic fluctuations. Low inflation doesn’t necessarily mean we can all raise our safe withdrawal rates. Certainly not one-for-one. There is neither empirical nor theoretical economic backing for materially changing your retirement strategy.

Only a little more than a year later the tide has turned. We’re now facing the highest inflation readings in about 40 years. 7.5% CPI and potentially 8% year-over-year once the BLS releases the February figure in mid-March. So, people asked me if my inflation views are symmetric, i.e., high inflation is also a non-event? As I signaled in my inflation post last month, I’m not too worried. Here’s why…

Before we begin… a favor to ask: Please check out my recent podcast appearance on the White Coat Investor. It’s also available on YouTube. Talking about Safe Withdrawal Rates, Robo Advisers, Target Date Funds, Annuities, Trading Options, and more.

### Back to Inflation…

Today, I want to perform a type of analysis that had been on my mind for some time but I waited for the right occasion to talk about it: I have extensive time-series data on safe withdrawal rates and a bunch of macroeconomic and financial observables, like the CAPE Ratio, 10-year bond yields, inflation number, etc. The economist/econometrician/statistician in me would scream: “that calls for running a regression to determine how different macro/finance fundamentals impact your safe withdrawal rate!” Essentially, estimate an equation of the shape

SWR = a + b1*StockEarningsYield + b2*Bond Yield + b3*ShortTerm Yield + b4*CPI + etc.

Why did it take me so long to perform this analysis? Well, to be honest, there are a few “snags” in this type of analysis that make it mostly an interesting **academic exercise**, but maybe a little less useful as a **practical tool **for an early retiree “in the trenches” trying to pin down a withdrawal rate. More on that later. But I still believe that this type of analysis can educate us how – at the margin – higher or lower inflation would impact the safe withdrawal rate derived from my Safe Withdrawal Rate Toolkit.

### Data used

For the safe withdrawal rates, I generate twelve different series with my Google Sheet Toolkit:

- 3 different Stock/Bond allocations: 60%/40%, 75%/25%, 100%/0% Stocks/Bonds
- 4 different assumptions on the length of retirement and the final portfolio target:
- 30 years horizon, FV=100% of the portfolio (capital preservation, after accounting for inflation)
- 30 years horizon, FV=25% of the portfolio, i.e., only partial capital preservation, say because
- 30 years horizon, FV=0% (capital depletion)
- 50 years horizon, FV=0% (capital depletion)

I will use each one of the 3*4=12 combinations (one at a time!) as the dependent variable.

For the explanatory variables (=independent variables), I use the following eight series:

- The Shiller CAPE earnings yield, i.e., the inverse of the CAPE ratio, at the beginning of retirement
- The 10-year benchmark bond yield at the beginning of retirement
- The short-term yield (e.g. 3-month T-Bill) at the beginning of retirement
- The 1-year CPI inflation (i.e., rolling over the past 12 months)
- The 1-year
**future**CPI inflation - The 5-year
**future**CPI inflation - The 10-year
**future**CPI inflation - The 30-year
**future**CPI inflation

Notice that only regressors 1-4 would have been observable and available at the start of retirement (subject to a small caveat because the CPI comes out a few days after the month-end). But, again as an academic exercise, I can certainly include **future **realized inflation to see how a retiree would have changed his/her withdrawal rate if he/she had indeed had the perfect foresight and had known the future realized inflation rates.

Some more technical notes:

- I run the regressions from 01/1920 to 12/1991, at a monthly frequency. Thus the last retirement cohort is the final cohort that had 30 full calendar years of actual portfolio returns.
- The 50-year retirement horizons would include up to 20 years of calibrated/estimated return data toward the end. Thus, we want to use those results with a grain of salt. But, then again, as I pointed out in Part 14 and Part 15, due to Sequence Risk, the portfolio returns during the latter part of retirement have relatively little impact on the SWR.
- All regressions use the Matlab/Octave package “nwest” to calculate the Newey-West heteroscedasticty-adjusted t-statistics. Simple Ordinary Least Squares (OLS) slope estimates are indeed correct, but the t-statistics would have been overstated due to the overlapping windows!

### Warming up: Univariate Regressions

As a warm-up, let’s look at the **univariate **regression results (y = a + b*x) of one specific SWR Series: 75%/25% portfolio, 30-year horizon, and 25% final value target. I use this set of “favorite” model assumptions often because it’s a great baseline for both early and traditional retirees. It works for a traditional retiree with a 30-year horizon who wants to leave a quarter of the portfolio as a bequest. Or an early retiree who wants to bridge 30 years until Social Security and Pensions set in and keep the 25% final value target to supplement those cash flows later in retirement.

Let’s look at the scatter plots of the independent variable (x-axis) and the safe withdrawal rates (y-axis). I group these into 4 charts with scatter plots each. Let’s start with the stock earnings yields and the 10-year bond yields, see below:

- The Shiller earnings yield has a strongly significant slope parameter (β=0.55, t=4.98) and a very impressive correlation of ρ=0.84. All the failures of the 4% Rule happen when the CAEY is below 5%, i.e., when the Shiller CAPE is above 20. Regular readers will know that I’ve been “preaching” that since 2016!
- The intermediate-term bond yield also has a positive impact on the SWR, but the relationship is certainly not linear. And it’s not even monotone either! For very low bond yields, historical SWRs were elevated again. The sub-4% withdrawal rate all occur in the “middle region” between 3% and 6.5%.
- By the way, regular readers will recognize the two charts (though updated with newer data) as part of my analysis debunking troll-extraordinaire Financial Sumoguy’s claim that we need to pin our withdrawal rate to the 10-year yield, and the 10-year yield
**alone**: “Do we really have to lower our Safe Withdrawal Rate to 0.5% now?” (August 31, 2020). The lesson back then: That’s really dumb. The 10-year yield is not very useful when determining a safe withdrawal rate of the average Stock/Bond portfolio.**Equity valuations matter most!**

Maverick’s back, baby. By Jeremy Freed May 21, 2022 Photographs: Getty Images, Vacheron; Collage by Gabe Conte Welcome to…

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