Sometimes it’s interesting to muse on a particular phenomenon without necessarily coming to any conclusion about it. Today, I’m musing about the advice financial advisors have given over the years about prudent levels of spending.


In the 1990s, midway in the historic Bull Market that started in 1982, everyone – financial advisors included, or maybe especially – was wildly optimistic. Clients were told they could spend 5% of their asset base every year without any fear of running out of money. True, there were niggardly naysayers,(1) but foundations spent 5% as a matter of law, and most endowed institutions spent at least 5%. So 5% it was.


Following the collapse of the Tech Bubble in 2000, many investors who had been spending 5% every year found themselves in trouble. If they had loaded up on hot tech stocks, they found themselves in real trouble. (Many tech funds lost 80% to 90% of their value between 2000 and 2002.) Financial advisors woke up and smelled the coffee and realized that, well, 4% was the real number. If you spent just 4% of your assets every year, you were ok. Definitely.


Beginning with the Credit Crunch in the summer of ’07 and continuing through the devastation of ’08 and early ’09, equity markets dropped more than they had since 1973-74, maybe more than they had since the Great Depression (depending on how you counted). That 4% we’d been so confident in now seemed positively bountiful. Who knew what lurked in the tails of those cute bell curves? Market catastrophes seemed to occur about 100,000 times more frequently than the math suggested. 3% was definitely the right number, no question about it.


If 3% was the number following the Great Contraction, what were we to make of the world we found when we woke up on January 1, 2013? Taxes on affluent investors (that is, the ones who can afford to pay my fees) skyrocketed. The combination of higher Federal income taxes, higher Federal capital gains taxes, the Obamacare surcharge, the reinstatement of the Pease amendment limiting the value of certain important deductions (state and local taxes, for example), and huge increases in state taxes was a major game-changer. On top of this, expected returns looking forward were likely to be constrained (cf., Reinhart and Rogoff) and correlations among asset classes were likely to remain high (thanks to sovereign and central bank interventions). If clients could safely spend 3% in 2012, surely they would have to drop that to 2% in 2013.


Anyone who thinks the Feds and the states are finished raising taxes on the “rich” obviously hasn’t counted the votes (or listened to Senator Patty Murray). Whether those increases happen in 2013 or later, they will happen. This will bring the prudent spending rate down to – ouch! – 1% of assets.


I don’t plan to retire any time soon, so I will surely live to see the day when I’ll have to tell my clients, “Sorry, Jack, I know you’re rich, but if you want to preserve your capital you actually can’t spend anything at all.”


(1) Financial planner William Bengen, for example, ran a careful calculation in the 1990s and famously concluded the correct number was 4.15% (astonishing accuracy!) No one paid any attention, partly because Bengen assumed we all owned a 60/40 stock/bond portfolio when everyone knew 90/10 was pretty conservative.


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Please note that this post is intended to provide interested persons with an insight on the capital markets and is not intended to promote any manager or firm, nor does it intend to advertise their performance. All opinions expressed are those of Gregory Curtis and do not necessarily represent the views of Greycourt & Co., Inc., the wealth management firm with which he is associated. The information in this report is not intended to address the needs of any particular investor.


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