The 4% Rule Works Again! An Update on Dynamic Withdrawal Rates based on the Shiller CAPE – SWR Series Part 54

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October 12, 2022

As promised in the “Building a Better CAPE Ratio” post last week, here’s an update on how I like to use the CAPE ratio calculations in the context of my Safe Withdrawal Rate Research. I have studied CAPE-based withdrawal rates in the past (see Part 11, Part 18, Part 24, Part 25) and what I like about this approach is that we get guidance in setting the initial and then also subsequent withdrawal rates based on economic fundamentals. That’s a lot more scientific than the unconditional, naive 4% Rule. In today’s post, I want to specifically address a few recurring questions I’ve been getting about the CAPE and safe withdrawal rates:

  1. Can a retiree factor in supplemental cash flows like Social Security, pensions, etc. when calculating a dynamic CAPE-based withdrawal rate, just like you’d do in the SWR simulation tool Google Sheet (see Part 28 for more details)? Likewise, is it possible to raise the CAPE-based withdrawal rate if the retiree is happy with (partially) depleting the portfolio? You bet! I will show you how to implement those adjustments in the CAPE calculations. Most importantly, I updated my SWR Simulation Google Sheet to do all the messy calculations for you!
  2. With the recent market downturn, how much can we raise our CAPE-based dynamic withdrawal rate when we take into account the slightly better-looking equity valuations? Absolutely! It looks like, the 4% Rule might work again! Depending on your personal circumstances you might even be able to push the withdrawal rate to way above 4%, closer to 5%!
  3. What are the pros and cons of using a 100% equity portfolio and setting the withdrawal rate equal to the CAPE yield?

Let’s take a look…

CAPE primer

Because I haven’t specifically written about CAPE ratios and their application to safe withdrawal rates in a while, let me just get everybody up to speed again on why and how CAPE ratios matter for retirees. Even if you don’t pursue a dynamic CAPE-based safe withdrawal rate, but prefer to use the standard Trinity Study-style calculations with a fixed withdrawal amount (though adjusted for inflation), CAPE ratios should matter for setting that withdrawal amount and percentage. Here’s again a chart from an earlier post to drive home this point. All the historical failures of the 4% Rule have occurred when the CAPE earnings yield (= one divided by the Shiller CAPE Ratio) was under 5%, i.e., when the CAPE Ratio was above 20. So it would be way too conservative to use a 4% Rule when the CAPE Ratio is in the low teens. But a 4% Rule might be way too aggressive conditional on facing a high CAPE ratio because the conditional failure probability is much higher than the (unconditional) failure probability you’d get from a Trinity Study.

Part 28 for the link and explanation) to the different valuation regimes, please see the screenshot of the table below. It’s the failure probabilities for different withdrawal rates (ranging from 3.25% to 5.25%) over the entire sample, but also conditional on equity valuations. For example, a 4% WR might seem somewhat safe with an 11.62% failure rate. But this disguises the fact that we encountered failures in 37% of the retirement cohorts when the initial CAPE ratio was elevated, at above 20. The failure rate rises even further, to 43.2% when both the CAPE was above 20 and the S&P 500 index stood at an all-time high at the commencement of retirement. (and I should note that this is the baseline scenario with a 60-year horizon, 25% final value target, and modest supplemental flows later in retirement coming from Social Security and a pension)

CAPE-based Dynamic Safe Withdrawal Rates – a primer

Just to get everyone back to speed on dynamic withdrawal rates, here’s a quick primer on the CAPE-based SWR rules. In the most basic setup, we calculate our withdrawal rate as

WR = intercept + slope / CAPE

Notice that our setup also encompasses, as a special case, another popular withdrawal rate rule: the Bogleheads variable percentage withdrawal (VPW) rule, if we set the slope to zero and fix the withdrawal amount to a certain percentage of the portfolio. But of course, we do want equity valuations to have an impact because economic fundamentals should matter. There are three neat features of using a withdrawal rate contingent on equity valuations:

First, we find an initial withdrawal amount that’s calibrated to be consistent with equity valuations. Second, our subsequent withdrawal amounts will adjust to changing portfolio values but also equity valuations. That’s a great improvement over the naive Bogleheads rule that uses a fixed withdrawal rate (though adjusted for retirement horizon). With a variable withdrawal rate, your withdrawal amounts will be significantly less volatile than the portfolio value. The portfolio may be down 20%, but the withdrawal amount is only down by, say, 10% because you also adjust the percentage withdrawal rate to reflect the better-looking CAPE ratio after an equity market correction.

Bellman’s Principle of Optimality. It implies that subsequent retirement planning decisions are following an optimal path, as though the retiree had simply re-retired under the new prevailing conditions. This Bellman Principle is violated in the naive Trinity-style fixed withdrawal amount calculations, and that always bothers me! But if you’re not a math geek, please ignore this one point! 🙂

If you’re familiar with my Google Sheet (see Part 28 for the most recent comprehensive guide to the sheet), you can enter supplemental cash flows to be taken into account in the traditional safe withdrawal rate simulations. But not in the CAPE-based simulations. As you might recall, I set up a separate tab where you can enter your future supplemental cash flows, like Social Security, pensions, home sales or purchases, anticipated nursing home expenses, etc. Until now, the CAPE-based rule is calibrated to target capital preservation and it ignores all supplemental cash flows. A reader asked me a while ago how he would factor in those supplemental flows. I had some ideas on how to “hack” my Google sheet, and I implemented those in the latest Google Sheet. This brings me to the next point…

Factor in supplemental cash flows and (partial or complete) asset depletion

So, here’s how to calculate that new CAPE-based withdrawal rate:

Step 1: CAPE Rule basics

We still calculate an initial CAPE-based safe withdrawal rate, assuming no additional cash flows and capital preservation. In this case, I use a CAPE of 27 and the following CAPE parameters: intercept=1.75% and the slope of 0.50, as I recommended in previous posts, e.g., in Part 18. So, the SWR calibrated for capital preservation and no additional cash flows would be…

WR = 0.0175 + 0.5 / 27 = 0.036

In other words, the initial CAPE-based SWR is 3.60%.

Now assume that the 75/25% portfolio takes a 20% hit in the stock portfolio and a 10% drop in the bond portfolio, which translates into a 17.5% drop in the overall portfolio. For simplicity, I also assume that this drop happens all at once. What would that do to the SWR calculations? First, the paper portfolio is down to $2,475,000. But the CAPE ratio also drops to 17.60. We would drop the monthly withdrawals to $10,299. But that’s only a 9.9% drop even though the portfolio is down by 17.5%.

So, there’s this nice offsetting effect that cushions the drop in the portfolio. Also, notice that because the drop in the portfolio happened instantaneously we slightly overstate the drop in the withdrawal amount. If the 17.5% drop in the portfolio had happened over the next several months, the target withdrawal amount would have been slightly higher because a) we would have already slightly shortened the remaining retirement horizon and b) we’d be increasing the present value of the future positive supplemental cash flows.

Even in the static withdrawal simulations, 4% and even 4.5%+ may work again!

How about the traditional Trinity-style simulations? Well, the rationale for higher withdrawal rates today, as in October 2022, is that since the market has already dropped by quite a bit, it would seem overly conservative to calibrate today’s withdrawal rate to the 1929 or 1968 market peak. Do I really believe that after a 23% or so drop in nominal terms and even a 28% drop in real terms, the stock market will now tag on another Great Depression-sized drop? Highly unlikely. What’s more realistic and reasonable is to calibrate the current (October 2022) withdrawal rate to historical situations that were equally beaten down from their respective recent stock market peaks. That’s easy to get from my spreadsheet! In the Main Results tab, there’s a table that lists the fail-safe consumption rates as a function of the equity drawdown. Turns out, that after a 20% drop, we already make the 4% Rule viable again. And in the real drop between 25% and 30% region, we’re already up at 4.17 and 4.38%, respectively. So, in light of the recent drop, we can be a little bit more aggressive.

A Sheep in Wolf’s Clothing“: Maybe we shouldn’t focus so much on the portfolio volatility. If we withdraw the 10-year rolling EPS from an equity portfolio then the earnings volatility rather than the portfolio volatility impacts our retirement happiness. And the annualized standard deviation of earnings was only 7%, much lower than the volatility of the stock market.

So, I wanted to check how a CAPE-based withdrawal rate with a slope of 1.0 and intercept of 0% would look in practice. Right now, with a CAPE of about 21, that would translate into a withdrawal rate of 4.76%, and that’s before the adjustments for supplemental flows and partial depletion of the portfolio, which could easily lift the rate to above 5%.

In any case, I first set the equity weight to 100% and all other asset classes to 0% in the main tab:

Sequence of Return Risk!

Bummer! Suddenly, the prescription from Victor Haghani’s article doesn’t sound so attractive anymore. Sure, the volatility of annual changes in withdrawals is low, around 4-6%, but that’s of little help if the trend is down 3.5-5.0% on average every year and 60-80% over a 30-year horizon.

So, unfortunately, the CAPE-based rule WR=1/CAPE doesn’t work so well in practice during the very deep bear markets in the 1920s, 30s, and 70s. But during the 2000s you would have fared very well, thanks in part to an extremely low initial withdrawal rate of only 2.37 at the peak in 2000. What also helped you is that the CAPE didn’t even drop below 10. The low point around the Global Financial Crisis was about 11 (based on month-end index data). The CAPE stayed below 15 for only 9 months in 2008-2009. So, there was never any risk of severely depleting your 100% equity portfolio. If we believe this pattern repeats in the current bear market you might get away with a 100% equity portfolio and this CAPE rule.

If you’re uncomfortable and worried about a sharp drop in withdrawals again, you could choose a rule slightly more cautious. For example, pick an intercept of -0.25% instead 0% and a slope of only 0.9 instead 1.0. I also added a feature of capping the CAPE withdrawal rate. An upper limit of 10% seems to work pretty well in the simulations. So, we’d limit the extreme drawdowns in the early periods, while also maintaining pretty solid initial withdrawal rates in today’s environment: 4.04% as the raw withdrawal rate and 4.49% when taking into account the supplemental flows and partial asset depletion.

Side note: A TIPS ladder approach

This side note has nothing to do with the CAPE, but I just wanted to mention how today’s improved bond valuations also improve our safe withdrawal math. Specifically, here’s another approach to make the 4% Rule work again: Invest in a ladder of TIPS (=inflation-protected government bonds) because real yields on TIPS have now reached levels that would easily sustain a perfectly risk-free retirement income stream, albeit only for 30 years. A quick look at the TIPS term structure on 10/11/2022 (via Bloomberg) tells me that the entire real yield term structure is now between 1.5% and 2% again.


That’s significantly better than I Bonds. They currently yield 0% real, giving you only a 3.33% safe withdrawal rate with depletion. And you can’t even move $1m all at once into I bonds due to the $10,000 per person/entity per year limit.


In the post last week, I introduced a few adjustments to the Shiller CAPE and they seem to shift the CAPE into a slightly more reasonable range. And sure, the market is still a bit overvalued. But chances are that we can push the CAPE-based withdrawal rate to 4% and above. Even higher when we take into account partial asset depletion and supplemental cash flows later in retirement. As someone in the comments pointed out, this is a bit of a “hollow victory” because you can apply a higher withdrawal rate but everybody’s portfolio is down since January 2022. Granted, but I still see folks applying 3% and even sub-3% withdrawal rates in today’s market. Relax, everybody, the risk of another bad market event on top of the current drawdown is low!

Likewise, with the adjusted CAPE quite close to dropping below 20 and the S&P 500 dropping more than 25% in real terms since the beginning of the year, I am also ready to announce that even in the traditional static SWR calculations, we should now safely move the withdrawal rate to 4% and above. Well, you heard it here first; the 4% Rule works again! And with a little bit of flexibility and a generous pension and Social Security benefits later in retirement, you can certainly go crazy and justify 4.5% or higher!

Thanks for stopping by today! Please leave your comments and suggestions below! Also, make sure you check out the other parts of the series, see here for a guide to the different parts so far!

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