Predictably Wrong
I DON’T USUALLY FOLLOW the NFL. But this year, I’ve made an exception—because the current season offers a valuable lesson not just for football fans, but also for investors.
Teams devote huge amounts of time, energy and money to determining who’s the best quarterback for their team. Yet, this year, three quarterbacks are leading their teams when most experts, who get paid to evaluate talent, didn’t give them much of a chance.
Brock Purdy leads the San Francisco 49ers. He was the 2022 NFL draft’s 262nd and final pick, and became a third-string quarterback. As a rookie last year, due to injuries to the team’s two other quarterbacks, he was elevated to starter and took the 49ers to the NFC Championship game.
Joshua Dobbs was the 2017 draft’s 135th pick, as well as the seventh quarterback to be selected. In seven years in the NFL, he’s bounced among seven teams, meaning the first six teams looked at him and decided they had better options. He started a total of 11 games for three teams. This season, only four days after being traded to Minnesota, he led the Vikings to victory over the Atlanta Falcons. It's not clear whether he'll remain the starting quarterback.
Finally, Aidan O’Connell was the 2023 draft’s 135th pick. He was the third-string quarterback for the Las Vegas Raiders this season until injuries to the two other quarterbacks meant he got the starting position, and he won his first two games.
To be sure, folks evaluating quarterbacks selected each of these players in the NFL draft. There are more than 250 Division I football teams and only 32 NFL teams, so just being selected says that the teams thought these quarterbacks were better than many of their college peers.
What does any of this have to do with investing? With investing as with football, here’s the issue: We’re just not very good at forecasting.
Investment researchers Morningstar recently published a report on how much a new retiree could safely withdraw each year from savings. Morningstar suggests that a new retiree might start by pulling out 4% of assets. This is up from its recent recommendations of 3.3% in 2021 and 3.8% in 2022.
I’m reminded of the old joke: How do you know economists have a sense of humor? Because they use a decimal point.
Don’t get me wrong: I think Morningstar provides a great service and thoughtful studies. One of the study’s authors is John Rekenthaler, who became my investment hero when I heard of the perhaps apocryphal Rekenthaler theorem. It states that, by the time the bozos know about an investment idea, it’s too late to make money with it.
As an engineer, I would apply a pretty wide margin of error to Morningstar’s retiree withdrawal rates. For starters, Morningstar estimated that, over the next 30 years, inflation will average 2.42%, stocks will return 9.41% and investment grade bonds will return 4.93%. Yes, the numbers come with two-decimal-point precision.
When doing ballistic calculations, I usually round the gravitational constant off to one decimal place. I think the Morningstar folks would agree that predicting 30-year returns is extremely difficult, and this type of precision is hard to justify.
Of course, this doesn’t mean that the Morningstar study isn’t useful. It most certainly is. Don’t focus on the exact numbers, but on the impact of changes:
The higher the expected return over inflation, the larger the percentage of your portfolio you can withdraw each year.
The starting valuation of stocks and bonds is critical to future returns.
Although a 100% stock portfolio leaves you with the largest ending balance most of the time, it also increases the risk of failure, thanks to stocks’ volatility.
By the same token, a 100% bond portfolio is unlikely to provide much growth, so the starting withdrawal rate needs to be lower.
The shorter the period you spend in retirement, the higher your withdrawal percentage can be.
Conversely, the longer you spend in retirement, the lower the percentage of assets you can safely withdraw. But the risk isn’t symmetrical. In other words, the increase in the withdrawal rate triggered by five fewer years in retirement is greater than the decrease caused by adding five extra years.
Even if you don’t buy the exact withdrawal rate suggested, the Morningstar study gives you a sense of what a safe withdrawal rate should look like: It’s probably a low to middling single-digit number. People who suggest that you can withdraw 10%, just because stocks have made more than that over some time periods, are likely to be proved badly wrong.
If you chose a starting withdrawal rate of between 3.5% and 4.5%, nobody’s likely to quibble with you—especially if, over the next 30 years, you’re willing and able to adjust the amount you withdraw based on your portfolio’s performance.
Kenyon Sayler is a retired mechanical engineer. He and his wife Lisa are extraordinarily proud of their two adult sons. He enjoys walking his dog, traveling, reading and gardening. Kenyon's brother Larry also writes for HumbleDollar. Check our Kenyon's earlier articles.The post Predictably Wrong appeared first on HumbleDollar.
