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.
