As the quote often attributed to Mark Twain goes "It is difficult to
make predictions, especially about the future." Nowhere is this
statement more relevant than making predictions about the stock market. In a recent discussion
of future stock market returns, a 12 percent market return going
forward was proposed. What is more dangerous is that an 8 percent
withdrawal rate for a retirement portfolio was suggested.
You
already know that the roughly 12 percent arithmetic average since 1926
overstates the average return for a longer period because a weighted
arithmetic/geometric average using Blume's formula is more appropriate
for longer horizons. We should also point out the danger of withdrawing
funds. Suppose you started withdrawing 8 percent of your initial
portfolio value in 2008, when the market lost about 37 percent. At the
end of the year, you only have about 55 percent of your original
portfolio left, so you have much less money left to go up with a good
market return. Research indicates that a withdrawal of 3 to 5 percent of
the initial portfolio value is much more likely to support your
retirement withdrawals, even with a 12 percent arithmetic average
market.
We would also like to ask you a trivia question:
When did the S&P 500 begin? Although you may think 1926 since that
is the beginning of the data used in the textbook, Ibbotson and
Associates create a proxy for the S&P 500 back to that date.
Actually, the S&P 500 was launched on March 4, 1957.
