International Diversification Can Raise the Retirement Safe Withdrawal Rate - Maybe a Lot!

Safe withdrawal rate (SWR) analysis is difficult because of limited data availability.  However, that doesn't mean we can't learn something from a limited data set.  Whenever the subject of adding international stocks to a portfolio in an attempt to improve it's SWR comes up the usual reaction is that there is not enough international data available to give an answer.

However, we do have good data since the 60's for the EAFE.  This is important since the period that had the worst SWR for most portfolio combinations is the mid to late 60's onward.  Yes, this period was even slightly worse than the late 20's crash when you look at how long a portfolio would've survived afterward.  Even though we don't have good enough data to look at both bear markets we do have enough for the single worst bear market - i.e. 1965 onward.  With this in mind I constructed the following portfolios and looked at the SWR's using all of the available data since 1965.   I assumed each year the portfolio would attempt to survive to 2003 so starting in 1965 the payout period was about 39 years and then less for each year afterward.  Here's what I got:

 

Commercial Paper   S&P500  EAFE  SWR (%)

 .25

 .75

3.8 

 .25

0

.75

5.0

 .25

.375 

.375 

4.7

 .25

.25 

 .5

4.9

 .25

.5 

.25 

4.5 

 

As you can see, adding EAFE made a huge improvement in the historical SWR numbers.  In fact, substituting EAFE for the S&P500 added a whopping 1.2%/yr. to the SWR, a > 30% improvement.  A 50:25:25 mix of EAFE: S&P500 :Comm. Paper was not far behind at 4.9%.

Will international diversification help us going forward?  We won't know the answer for a long time but I suspect that the value of international diversification may even be greater going forward.  This is because for most of the past few decades neither the S&P500 or the EAFE were valued particularly high or low relative to each other.  Now, however, the relative valuations have diverged and the S&P500 is trading at significantly richer valuations relative to the EAFE.  I think that for this reason the EAFE has the better prospects in the next few decades.  I'd be very leery of letting the equity portion of my retirement portfolio ride 100% on the S&P500 or TSM (Total Stock Market) index.

Last edited: 06/28/2004

 

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