What if you could predict the future?
Yeah, I know: You'd find all the stocks that will be huge gainers a few years from now and buy them. You'd know what trends to jump on, where not to buy oceanfront property, and which pharmaceutical giant will eventually discover the cure for cancer. You'd be insanely rich, better-looking, incredibly healthy, and have an awesome spouse.
Wouldn't you? I sure would. I'd have bought Amazon.com (NASDAQ:AMZN) in 1997, Marvel Entertainment (NYSE:MVL) for $1 a share in 2000, Wal-Mart (NYSE:WMT) for $0.11 in 1979 … you get the idea. And I would have sold them all at their peaks, of course.
But meanwhile, we're stuck here in reality, trying to figure out whether companies like BP (NYSE:BP) and Diageo (NYSE:DEO) are going to be able to sustain their dividends through the rest of this economic mess, whether Starbucks (NASDAQ:SBUX) is really just another coffee seller, and whether Pfizer's (NYSE:PFE) huge settlement with the U.S. Department of Justice is really that big a deal.
Yep, the nitty-gritty of stock analysis is far from a sure thing. As far as I know, nobody has come up with a way to predict the future with enough specificity to pick sure-thing 50-baggers today.
But it turns out that there is a way to get a very general look at where the market is likely to go in the next several years. And while that probably isn't enough to make us all rich, it does have one very important application that could have a huge impact on your life.
Seeing the future -- and why it matters
Financial planner and researcher Michael Kitces has been studying the history of market valuations for several years now, and his research has come up with an unsurprising result: When stocks are, in the aggregate, overvalued, market returns over the next 10-15 years are likely to be lower than the historical average of about 10%. And likewise, when stocks are undervalued, returns in the coming decade-plus are likely to be way above average.
Shocking, eh? While it sounds like a "duh" sort of result, it's the research and careful evaluation that makes information like this useful. Of course, as Kitces regularly points out, the market's valuation is somewhere in the great gray middle about two-thirds of the time, and when that's true, he can't make any reliable forecast.
But I hear you asking, "So what? That's not all that relevant to my stockpicking." Indeed, it probably isn't. But if you're nearing retirement, it could be extremely relevant. Here's why.
If you ever plan to retire, this is a big deal
If you were to ask a financial planner how much money you should draw out of your nest egg when in retirement, you'll probably get what has become a pretty standard answer: 4% of your balance at retirement, more or less.
Of course, the devil is in the details -- in this case, in that "more or less" -- and that's why most folks give the 4% number, which in truth is a conservative answer. The goal, of course, is to take out as much as you can every year while ensuring that you don't run out of money before you die. It's a daunting problem to try to solve, and many folks "solve" it by taking less money than, in retrospect, they could have.
But as Kitces explained in an interview with the Fool's Robert Brokamp, excerpted in the new issue of Rule Your Retirement, his real goal is to try to solve that problem. Specifically, if the market is over- or under-valued, does that give us any guidance as to how we could adjust that withdrawal rate?
His answer is that it does: Depending on where the market's valuation is when you retire, your "safe withdrawal rate" can range from 4.4% to 5.7% of the initial value of your portfolio every year.
That's a big deal. Consider: If you've got a $2 million nest egg on the day you retire, and you follow the conventional wisdom and take 4%, that's $80,000 a year. Even Kitces's worst-case-scenario 4.4% gives you an extra $8,000 a year, with only a tiny chance that you'll outlive your money, he says. And at 5.7% you'd be drawing $114,000 a year -- again, safely, if you follow his guidelines.
Big difference, isn't it? See, fortune-telling does have some benefits.
Of course, there's a little more to it than that. If you'd like to learn more about the results of Kitces's research, including his asset allocation recommendations for retirees (which are a big part of this), check out the full interview in the brand-new issue of Rule Your Retirement. It's a paid service, but if you're not a member, a free trial will give you full access for 30 days -- plenty of time to read and ponder these recommendations. Just click here to get started.
