This is especially the case if our everyday observations sort of suggest the statements are right. Few will stop to question their validity – what are the assumptions embedded in those statements, who made those statements and to what purpose; have robust tests been done to verify claims made in those statements?
In the field of investment, one wisdom often purveyed is that of life-cycle investing. The theory goes that young people should be more aggressive in their investments, i.e. they should allocate a higher proportion of their portfolios to equities for long-term compounding effect to take place. But as a person nears retirement age, the person should cut exposure to equities and hold more portfolios in bonds and cash.
This makes intuitive sense. Equity prices are more volatile than fixed income instruments, and unlike the latter, there is no assurance of regular pay-outs from equities. As such, it would be “safer” for retirees, who are dependent on their life savings for their daily expenses, to park their money in a less volatile portfolio. What if the retirees had their entire life savings in equities, and saw their portfolio diminish to less than half during the global financial crisis in 2008? That would be a nightmare scenario, wouldn’t it?
This scenario is likely to be most vivid when the stock market crash is at its worst. At that point, we see in our minds retirees with their wealth halved compared to the pre-crisis level. “Poor things!” we’d think. “That’s why retirees shouldn’t put all their nest eggs in the stock market.”
But do you know that the market recovers even from the worst of crises. As long as the retirees don’t panic and cash out the entire portfolio at the bottom of the market, there is a good chance that they would see their portfolio recover.
We did a stress test on an all-equities portfolio at each of the previous market peaks in the Singapore market going as far back as 1973. Let’s assume that there were seven retirees.
Each retired with S$1mil and decided to put the entire sum into the stock market. The bull markets at the time of their retirement gave them confidence that the stock market was a good place to keep their savings. So each of them plonked their S$1mil into the market on the last day of 1972, 1981 1983, 1989, 1996, 1999 and 2007. And each wanted to withdraw 5% from that S$1mil, or S$50,000 a year, to pay for their living expenses.
As it turned out, the years that the seven retirees put their money into the market were the years of market peaks. Soon after, major crashes or market corrections took place.
Can the S$1mil equities portfolio last them till today?
Financial crisis
Well, six out of the seven portfolios did. The initial S$1mil portfolios were worth between S$738,000 and S$3.2mil as at end-2013. For the person who retired at end-1981 with S$1mil invested entirely in the Singapore stock market, her portfolio as at the end of last year was worth S$3.2mil. This was after she withdrew S$50,000 a year for the last 32 years for a total of S$1.6mil from the portfolio.
As for the person who retired on the eve of the Asian financial crisis, her portfolio as at end of last year was worth S$1.5mil. And in the intervening years, she had taken out S$850,000 to spend.
From the table above, you can see that the two who retired on the eve of the two most recent market crashes – the dotcom bubble burst in 2000 and the global financial crisis in 2008 – still had S$738,000 and S$758,000 in their portfolios respectively.
At 5% withdrawal rate, the lowest the six retirees’ portfolios ever fell to was S$417,000. That was for the person who retired at the peak of the dotcom bubble. But as long as there is still money in the market, there is a chance of recovery.
The only retiree whose portfolio didn’t survive was the one who put her money into the market during the massive 1973 bubble in the Singapore market. At that time, according to data from Thomson Datastream, the Singapore index was trading at a price-earnings ratio of 35 times.
It was the time when OCBC was trading at S$50 a share and Metro was at S$26. In other words, there was a massive bubble in the Singapore market at that time.
At a 5% withdrawal rate, her money was depleted by end-1983. But if she had reduced her withdrawal rate to 3%, i.e. take out S$30,000 instead of S$50,000 a year to spend, she would have survived the numerous crashes that followed and she would still have an equities portfolio of S$848,000 as at end of last year.
For the above calculations, we use the Thomson Datastream calculated Straits Times Index as a proxy for how an all-equities portfolio would have performed. Dividends are added to the portfolio. No transaction costs are taken into account. The portfolios are valued once a year on Dec 31, and withdrawals are done on that day as well.
I couldn’t find Malaysian market data that go as far back. But investors here will be happy to note that over the long term, the Malaysian equities market tend to outperform the Singapore market. So the results above are applicable to Malaysia, with an even greater buffer. And if one is able to construct a portfolio of stocks that can outperform the market index over time, then there is an even greater margin of safety.
So what are the main takeaways from the above study?
Chances of an all-equities portfolio being wiped out at a withdrawal rate of 5% a year is minimal under normal market conditions. The exception is when someone buys into the market at the peak of a massive bubble, as was the case in 1973. (For readers who would like to stress-test their retirement funds over various cycles in the US going as far back as 1871, you can go check out the website
Rough ride
Another noteworthy point is that as long as the portfolio is not decimated, and so long as the money stays invested in the market, there is a good chance of recovery given time. But admittedly, the ride can be quite rough at times. The portfolio can plunge by half in a year. The key is to hang on tight.
So the upshot is that one who has S$1mil can safely withdraw S$50,000 a year to fund one’s retirement for as long as one lives, and still leaves an estate for one’s children if one puts the entire sum in the equities market.
Time to say goodbye to perpetuals, annuities and bonds – which usually form the core of a retirement portfolio!
But there is one very important caveat here. The equities portfolio must be made up of a diversified basket of stocks of real businesses, and purchased at cheap or fair prices which are not likely to result in a significant permanent loss of capital. Buying into speculative stocks which have scant business prospects and at way overvalued prices, is a sure-fire way for one to outlive that S$1mil in the shortest possible time.
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