Another guest post by everyone’s crazy PF guy Rob Bennett. For the record, I really like this post. It’s short and to the point. It does a good job of giving all of us a decent primer to what the heck he’s talking about.

My question to Rob is this: If a retiree has say 80% of her portfolio in bonds, how does that affect the way things are calculated? Do bond valuations get factored into Rob’s formula?

Anyway, without further adieu, let me give the floor to Rob.

Matt and Sam both retire with $1 million portfolios. Mike plans to take out $40,000 to cover each year’s living expenses. Sam plans to take out $80,000. Which retirement is safer?

Your first thought is probably that Matt has the safer retirement. He’s withdrawing only 4 percent of portfolio value each year while Sam is withdrawing 8 percent.

Not so fast. To know which retirement is safer, you need to look at what valuation level applied at the start of each of the two retirements.

If Matt retired in 2000, when stocks were priced at three times fair value, the true value of his portfolio was only $350,000. His true withdrawal percentage is three times 4 percent, or 12 percent, That’s a dangerous withdrawal percentage.

If Sam retired in 1982, when stocks were priced at one-half fair value, the true value of his portfolio was $2 million. His true withdrawal percentage is one-half of 8 percent, or 4 percent. That’s a safe withdrawal percentage.

It turns out that Sam’s retirement is a whole big bunch safer than Matt’s. But you wouldn’t know it by using the retirement calculators available on the internet today.

None of today’s retirement calculators (except for the retirement calculator that I developed — The Retirement Risk Evaluator) contain an adjustment for the valuation level that applies on the day the retirement begins. Dallas Morning News Columnist Scott Burns explained why in a June 2005 column — “It is information most people don’t want to hear.” Most of us want to hear fairy tales about stock investing during a bull market and most “experts” are happy to go along.

It’s our desire to hear fairy tales and the willingness of the “experts” to go along that causes failed retirements. Valuations matter. We need to start taking valuations into consideration when telling people whether their retirement plans are safe or not.

Rob Bennett created the Investor’s Scenario Surfer, a portfolio allocation calculator. His bio is here.

Tell everyone, yo!