Morningstar - Q4 2021 - 14

Dispatches
EXHIBIT 1
Dwindling Real Cash Flow The bond's yield stays constant while the effects
of inflation accumulate.
Treasury Bond Yields 8.45% at Time of Purchase, 1990
(Assumes the Trailing 10-Year Inflation Rate, $100,000 Investment)
Nominal
Real
8,450
Nominal
Real
8,450
1,997
Year 1
Year 5
Year 10
Sources: Morningstar Direct, author's calculations
3,000
1,997
EXHIBIT 2
Year 1
Year 5
Nominal Withdrawals
Real Withdrawals
Year 10
8.45%
Year 15
4%
Year 20
Smoothed Real Withdrawals (Reinvestment Rate)
0%
Year 30
Smoothing Income Receiving stable real cash flows requires reinvesting a portion
of the bond's payments to be used later.
Smoothed Real Withdrawals, 1990 (Assuming the Trailing 10-Year Inflation Rate, $100,000 Investment)
Nominal Withdrawals
8,450
Real Withdrawals
Smoothed Real Withdrawals (Reinvestment Rate)
0%
8.45%
4%
5,010
3,750
1,997
Year 1
Year 5
Year 10
Year 15
Year 20
Year 30
5,010
3,750
1,997
Year 1
Year 5
Year 10
Sources: Morningstar Direct, author's calculations
Year 15
Year 20
Year 30
6,000
4,330 $9,000
8,450
3,000
6,000
4,330
3,000
$9,000
The good news for 2021's freshly minted retirees
is that there is less uncertainty with Treasury
bonds than there was three decades go.
Unfortunately, that is because today's Treasury
payouts are paltry. With a yield of just 1.89%, the
30-year Treasury generates little cash. Its
reinvestment risk, therefore, is low-but so, under
all reasonable interest-rate projections, is its
real withdrawal rate.
Smoothed Real Withdrawals, Today
(Assuming the Trailing 10-Year Inflation Rate,
$100,000 Investment)
Withdrawal
Nominal Withdrawals
Smoothed Real Withdrawals
(4% Reinvestment Rate)
Smoothed Real Withdrawals
(2% Reinvestment Rate)
Smoothed Real Withdrawals
(0% Reinvestment Rate)
would spend $5,266 (the figure being slightly
higher owing to inflation) and pocket the
rest. And so forth.
In Year 20, the excess proceeds would reach their
peak value and then recede. (That crossover is
not portrayed on the graph, so don't squint trying
to find it!) The downturn occurs more rapidly
14
Morningstar Q4 2021
than the rise, because after several decades, the
number of nominal dollars required to maintain
real spending becomes alarmingly high. In
this case, the Year 30 withdrawal is $21,199-more
than 4 times the Year 1 amount and 150% above
the bond's nominal yield. The logic is similar when
the reinvestment rates are 4% and 0%, but of
course the withdrawal rates are lower, at $4,330
Source: Morningstar Direct, author's calculations.
K
John Rekenthaler is a vice president at Morningstar
Research Services LLC. He is quick to point out that the
views expressed in Ivory Towers are his own.
Annual Rate (%)
1.89
1.53
1.49
1.45
Year 15
Year 20
Year 30
$9,000
6,000
$9,000
3,000
6,000
Looking Ahead
This was a relatively easy exercise, because
Treasury bonds can neither be called nor (absent
circumstances too dire to contemplate) will
they default. Investing in other bonds complicates
the analysis, as does treating inflation more
realistically. For these projections, I assumed
that the next 30 years' inflation rate would match
that of the past decade. That's an acceptable
starting point, but as the post-1989 history
demonstrated, other possibilities should properly
be tested.
and $3,750, respectively. Pity the retiree who
belatedly realizes that the apparent simplicity of
buying and holding Treasury bonds is illusory.
What really matters are real receipts, but
estimating them leads to wide disparities,
depending on one's assumptions.

https://www.morningstar.com/authors/208/john-rekenthaler

Morningstar - Q4 2021

Table of Contents for the Digital Edition of Morningstar - Q4 2021