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Reality Check

Adam M. Grossman

A QUOTE OFTEN attributed to Mark Twain goes as follows: “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”

This certainly applies to personal finance, and it’s why it can be helpful to take a step back sometimes to revisit widely held notions—including these six.

1. Social Security. You may have heard of Social Security’s “earnings test,” which can reduce the size of monthly checks for those who continue working after claiming benefits. It’s often perceived as a penalty, and indeed it can be substantial. Benefits are generally reduced by one dollar for every two dollars earned. For that reason, some people stop working just to avoid having their benefits cut.

What is often overlooked, however, is that the earnings test only reduces a worker’s benefits temporarily, until he or she reaches full retirement age (FRA) of 66 or 67. Once a worker reaches FRA, his or her benefit is increased by an amount that makes up for the earlier cut. Despite its reputation, the test shouldn’t be a disincentive for those who want to continue working after starting Social Security.

2. Portfolio withdrawals. You may be familiar with the 4% rule for taking withdrawals from a portfolio in retirement. This 4% figure came out of research first conducted in 1994 by financial planner William Bengen, and it’s come to be seen as the gold standard for a safe retirement withdrawal rate. But in all his presentations and writings over the years, Bengen has emphasized a key point: that we really shouldn’t be so wedded to 4% that we treat it as a rule.

Bengen notes that, in his own practice, he always used 4.5%, and he argues that a withdrawal rate of 5% or higher might be justified. Yet investors—myself included—always seem to come back to 4%, despite Bengen himself telling us that this isn’t the only answer.

That dissonance, I think, is instructive. It illustrates how easy it is to become anchored to rules of thumb—and why it’s so important to revisit first principles before making big decisions.

3. Bubble worries. Quite frequently, investors will challenge me to explain why a crash like the one we saw in 1929—when the stock market dropped 90%—couldn’t happen again. There are several reasons I believe a crash of that magnitude would be unlikely. At the top of the list: I believe the Federal Reserve would step in and wouldn’t let markets simply plummet.

But there’s another, more basic factor to understand: The crash that started in 1929 didn’t come out of nowhere. It was preceded by a period of excess—the Roaring Twenties—that caused the market to become extremely overvalued. The Dow Jones Industrial Average had risen six-fold in the eight years leading up to the crash. It was clearly in dangerous territory. That’s another reason we shouldn’t view 1929 as the sort of thing that could happen again at any time and with no warning.

4. Market valuation. Those who worry most about today’s market often point to the CAPE ratio, a valuation indicator created by Robert Shiller, an economist at Yale who won the Nobel prize for his work studying market behavior. Given Shiller’s background, many take the CAPE seriously and worry that it’s at an elevated level.

There are reasons, however, this might not be the ominous sign that it appears to be. According to a recent analysis, one of the CAPE’s key strengths is also one of its weaknesses: Shiller’s data set goes back more than 100 years. But since markets change over time, it may not be an apples-to-apples comparison to measure today’s CAPE reading against historical levels.

For example, the profits of today’s market leaders are increasing more quickly than companies in the past. That means they might “grow into” their elevated valuations. There are also more technical, accounting reasons the earnings of companies today may not be directly comparable to profit figures from the past. In short, the CAPE ratio may not be telling us what it appears to be telling us.

5. Stock-picking. You may recognize the name Benjamin Graham. He’s often referred to as the father of investment analysis. And he’s revered, especially by stock-pickers, because he was Warren Buffett’s teacher and mentor.

But that overlooks a key change in Graham’s thinking late in life. In a 1976 interview, this is what he had to say about the usefulness of stock-picking: “I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook ‘Graham and Dodd’ was first published; but the situation has changed a great deal since then…. I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost.”

6. Private funds. In the past, I’ve cited research on private funds, such as private equity and hedge funds. What the data show is that the gap between the best and worst private funds is much wider than the corresponding gap among standard, publicly available funds. In other words, the best private funds are dramatically better than average, and the worst private funds are dramatically worse than average.

Since private funds are capped by law at a relatively small number of investors, it’s very difficult for individual investors—even very wealthy individuals—to access the best funds. Those slots are reserved for the largest endowment funds, because they can write the largest checks. That exclusivity has led to the perception that these elite funds are delivering top-notch returns.

But that may not be the case. Comprehensive data on private funds aren’t available, but a handful of data points suggest that they may not be doing as well as we think they are.

Gregory Zuckerman covers hedge funds for The Wall Street Journal and knows the industry well. In a recent post, Zuckerman provided these figures for 2024: “David Tepper, David Einhorn and Alan Howard are three of the most successful investors of their generation. Their key funds gained 8%, 7.2% and 4.7% last year.” In other words, the S&P 500, which rose 25% in 2024, ran circles around the “best” funds.

Another data point from an insider: Last year, former Harvard president Larry Summers commented on Harvard’s endowment, more than 70% of which is invested in private equity and hedge funds. Despite it having access to the very best funds, Summers argued that Harvard’s endowment has lagged its peers so much that it would be $20 billion larger today if its returns had been just average.

According to more than one analysis, individual investors should actually be grateful that we don’t have access to these exclusive funds. As Mark Twain might have said, the notion that Ivy League schools are enjoying steady market-beating returns “just ain’t so.” Indeed, the data suggest a simple mix of stock and bond index funds has delivered better results than these elite private funds.

Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.

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Jon Daley
16 days ago

For RET, it seems like the example you linked to proves the opposite? That you’ll only break even if you live to 85 and that doesn’t take into consideration all those hours working in the early years?

I’m not planning to work after I start taking SS at FRA so it won’t matter for me, and we aren’t really planning on it, but I don’t expect my wife to work after taking SS at 62. My assumption is that if she did have a reduction on in her own SS due to working is that it wouldn’t get replaced when she starts taking the spousal benefit?

Dan
16 days ago

I appreciate reading your insightful comments, it’s always critical to review the fallacies or possible fallacies of financial generalizations. Many commenters have offered well-informed alternative considerations for some of your points. In a related sense, I would add two larger concepts to consider: 1) the Depression years would have been much better had the Fed acted appropriately to stem the negative tide at the time. I also doubt that the modern Federal Reserve would ever allow a recurrence of that magnitude of loss. Today’s equity market still represents a historic high on a valuation basis and caution should be used for retirees. The positive situation today is that the fixed-income market offers a viable alternative return and asset allocation should now work much more effectively than the past decade. 2) the 4% “rule” is often misunderstood. There are a host of individual factors that can decrease (or increase) that withdrawal rate. The 4% is based on tax-deferred, not taxable accounts; it does not consider the offsetting income benefit of social security payments; it uses a 50/50 allocation between stocks and bonds; and it largely assumes “success” as not running out of money. On the latter point, many consider maintaining a meaningful portion of liquid net worth for heirs, in which case, a lower withdrawal rate between 3% and 3.5% is a much safer rate.

Last edited 16 days ago by Dan
Norman Retzke
21 days ago

A few observations.
 
Point 3 Bubble worries: “The crash that started in 1929 didn’t come out of nowhere. It was preceded by a period of excess—the Roaring Twenties—that caused the market to become extremely overvalued.” It is my understanding that, adjusted for inflation the S&P 500 is at an all-time high of $5,996. It was $330 in 1980. According to MoneyChimp the worst returns for the stock market 1871-2024:
1931   -44.2%
  2008   -37.2%
1937   -32.1%
1974   -27.0%
1907   -24.2%

Point 2 Portfolio withdrawals: ”But in all his presentations and writings over the years, Bengen has emphasized a key point: that we really shouldn’t be so wedded to 4% that we treat it as a rule.” Alternatives have been extensively researched, which are described a “flexible approaches”. These include beginning with RMDs, adjusting the amount (or not) for inflation, a “guard-rail” approach, etc. There’s an article over at Morningstar about this, and I don’t think it is behind a paywall:

https://www.morningstar.com/retirement/best-flexible-strategies-retirement-income-2

==
I recall the 1974 market. It was my first exposure to serious declines. However, I was not invested at the time. I vividly remember some of the engineers at the firm complaining “It doesn’t matter what I buy, it all goes down.”  That experience provided me with some caution.
 
I’ve researched the different withdrawal approaches and I use a flexible approach, beginning with the Required Minimum Distribution and adjusting from there. This has worked well for me.

Last edited 21 days ago by Norman Retzke
parkslope
22 days ago

As was the case in your article on Dec 22, 2024, you limited your comments about issue #3 Bubble Worries to the crash of 1929. Thus, I respectfully think it is worth reposting the comment I made about that article.

This article does a good job of explaining why a “1929-style decline” isn’t something we should worry about. However, it doesn’t address whether there is less risk of the much more recent sell-offs that happened with the dot-com bust when stocks dropped ~39% or when stocks dropped ~43% in 2008-2009. Sometimes I think many have already forgotten that the market didn’t exceed its high in Dec 1999 until Nov 2013.

jay5914
22 days ago

Thanks for another thoughtful article Adam. I love that (attributed to) Mark Twain quote. Items 1-2 and 5-6, I agree very much with your points. Items 3 and 4, I see differently.

“3. Bubble worries.”
“Quite frequently, investors will challenge me to explain why a crash like the one we saw in 1929—when the stock market dropped 90%—couldn’t happen again. There are several reasons I believe a crash of that magnitude would be unlikely.” At the top of the list: I believe the Federal Reserve would step in and wouldn’t let markets simply plummet.”

It still amazes me how many smart people continue to make the case that the Federal Reserve will always be able to control the market as it sees fit. I concede that for at least the last 15 years the Fed has continued to increase its role in the stabilization of markets through each “crisis” we have faced. As you also seem to imply, it has become accepted by many that this has created an implied floor to the financial markets. To me, this confidence in the Fed has played a large role in the stock market advance of recent years. However, I consider this a great risk the longer this goes on. Normal economic and market cycles are being “managed” to an extreme. Can the corresponding money printing and government debt levels continue higher forever? Honestly, none of us knows.

“But there’s another, more basic factor to understand: The crash that started in 1929 didn’t come out of nowhere. It was preceded by a period of excess—the Roaring Twenties—that caused the market to become extremely overvalued. The Dow Jones Industrial Average had risen six-fold in the eight years leading up to the crash. It was clearly in dangerous territory. That’s another reason we shouldn’t view 1929 as the sort of thing that could happen again at any time and with no warning.”

DJIA recent high of 45k is also up six-fold since the 2009 financial crisis low and has a roughly 14-15% compounded return during that 15 year period. Has this been a “period of excess” and has the “market become extremely overvalued?” Yourself and many others don’t think so. Again, none of us really knows.  

“4. Market valuation.”
Is the CAPE ratio less relevant today as you imply? Maybe, but the argument sounds a lot like “this time is different.”  

As Chuck Prince said “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance.”  For now, the music continues to play.

Whatever the markets bring, best of luck to all in 2025.

Last edited 22 days ago by jay5914
Jack Hannam
22 days ago

I have no idea whether Mark Twain actually said it, but its my favorite quote attributed to him. I liked your discussion about comparing CAPE ratios today with those from the past, and also Ben Grahams evolved opinion on stock picking.

As you know, Jonathan discussed withdrawal strategies in “Spending It” eight days ago. (Sorry, I’m unsure how to link the post). In his response to a comment from “baldscreen”, he wrote that each individual can weigh the relative importance of a predictable annual income, and protection from inflation, portfolio depletion and rough markets. Then choose the most suitable option.

Thanks for another interesting post, Adam.

Jonathan Clements
Admin
22 days ago
Reply to  Jack Hannam

It seems we don’t know who first said the words attributed to Twain:

https://quoteinvestigator.com/2018/11/18/know-trouble/

Ben Rodriguez
22 days ago

[I]ndividual investors should actually be grateful that we don’t have access to these exclusive funds.”

Such a great point. I’ve never understood the fascination with these funds that deliver subpar returns at expensive prices.

Winston Smith
22 days ago

Adam, another excellent post!

Please keep them coming!!

Marjorie Kondrack
22 days ago

Thanks for your thoughts, Adam. I’ve always thought that the 4% general rule should be adjusted through the various stages of life.
Perhaps a larger percentage could be allocated during the early years of retirement when people spend more on travel and home improvements.

mytimetotravel
22 days ago

I think I have seen reference to a “smile”. A higher rate initially, in the “go-go” years, a lower rate as you slow down, and then a higher rate again as you need more care. Of course, if you have a LTC policy you may not need the higher rate later in life, but many of us do not.

David Lancaster
21 days ago
Reply to  mytimetotravel

You are right Kathy. The retirement spending smile idea was first proposed by Dr. David Blanchett an adjunct professor of wealth management at The American College of Financial Services and co-host of the Wealth, Managed podcast.

Brent Wilson
22 days ago

I agree and don’t think this idea gets enough attention. The standard analysis is always chance of success based on a static withdrawal rate throughout retirement.

I’m more interested in my chances of success assuming a higher initial withdrawal rate (i.e. 5%) in the first ten-ish years of retirement, as this could be when you are bridging the gap between retiring and collecting social security. Then, after you begin social security, the withdrawal rate could be adjusted downward to 3-4%. This is what I want analysis for.

I suspect many have worked longer than they needed, targeting 4% as a must-have number to acquire before they retire. But could they have retired with an initial 5% withdrawal rate, if they were willing to adjust it downward later?

Last edited 22 days ago by Brent Wilson
Edmund Marsh
22 days ago

Great advice. Six examples that show our actions can be swayed by persistent, low-key notions just as wrongly as by immediate, emotionally-charged beliefs.

1PF
22 days ago

In #2, another part of Bengen’s 4% “rule” that’s often overlooked is the portfolio composition used in his analysis: 50% common stocks, 50% intermediate-term U.S. treasury bonds.

Jon Daley
16 days ago
Reply to  1PF

Thanks for that stat. I didn’t know it was high as 50% bonds. That makes more sense when I look at theoretical plans and it seems that money could grow much faster than I would spend it.

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