CAPE-based withdrawals: letting market valuations set your spending
The 4% rule uses the same withdrawal rate whether stocks are dirt cheap or wildly expensive — which is a bit mad. CAPE-based withdrawals fix that, spending less when the market is pricey and more when it's cheap. The elegant finale to the series.
Here’s an oddity that should bother you more than it does. The 4% rule tells a person retiring into a wildly overpriced market to withdraw exactly the same 4% as a person retiring into a bargain-basement one. But those two retirees face completely different futures — expensive markets tend to deliver weaker returns, cheap markets stronger ones. Using one withdrawal rate for both is like driving the same speed in a downpour and on a clear day. CAPE-based withdrawals fix that, and they make a fitting finale to our withdrawal tour: the most intellectually satisfying strategy of all, and a neat illustration of why sequence risk exists in the first place.
What CAPE is
CAPE stands for the Cyclically Adjusted Price-to-Earnings ratio, popularised by the economist Robert Shiller (so you’ll also see it called the “Shiller PE” or PE10). An ordinary price-to-earnings ratio divides the market’s price by one year’s earnings, which is noisy — a single bad year of earnings makes stocks look artificially expensive. CAPE smooths that by dividing today’s price by the average of the last ten years of inflation-adjusted earnings. The result is a reasonably stable gauge of whether the stock market, as a whole, is expensive or cheap relative to its own history.
A high CAPE (say, well above its long-run average) means investors are paying a lot for each pound of earnings — the market is pricey, and history suggests future returns from here are likely to be muted. A low CAPE means stocks are cheap, and future returns have tended to be stronger. It’s far from a precise forecast — CAPE says nothing about next year — but over a long horizon, starting valuation has been one of the better available signals of the returns to come. And “the returns from here” is precisely what a retiree’s withdrawal rate should care about.
The strategy: rate follows valuation
The insight is simple once CAPE is in hand: your safe withdrawal rate shouldn’t be a constant, it should move with valuations — lower when the market is expensive (because lean returns are likely and sequence risk is high), higher when the market is cheap (because strong returns are likely).
The classic way to wire this up, developed in the retirement-research literature, is a formula built on the inverse of CAPE — 1/CAPE, which is the market’s “earnings yield,” often written CAEY. A common parameterisation looks like:
withdrawal rate = a + (b × 1/CAPE)
with a a small constant and b a multiplier — one well-known version uses roughly a = 1.5% and b = 0.5. Don’t get lost in the constants; feel the mechanism. When CAPE is high, 1/CAPE is small, so the formula spits out a lower withdrawal rate — the strategy tells an expensive-market retiree to tread carefully. When CAPE is low, 1/CAPE is large, so the rate rises — a cheap-market retiree is told they can safely spend more. The rate breathes with the market’s valuation, tightening when the danger is greatest.
Some versions set the rate once at retirement based on the CAPE you retire into; more dynamic versions recompute it each year so your spending keeps responding as valuations shift over your retirement.
Why it targets sequence risk so precisely
What makes this strategy elegant is why it works, and it ties the whole series together. Recall from the FIRE series that sequence-of-returns risk — a bad market early in retirement — is the thing that actually breaks a plan. Now notice: when is a bad early sequence most likely? Disproportionately when you retire into an expensive market, because high valuations are exactly the condition that precedes weak or negative returns. High CAPE is, in effect, an early-warning light for elevated sequence risk.
So a CAPE-based rule isn’t just responding to markets in general — it’s automatically tightening your belt in precisely the conditions where sequence risk is most dangerous, and loosening it when the coast is clear. It’s the only strategy on the tour that adjusts spending based on a genuine forward-looking signal about the risk it’s trying to avoid, rather than reacting after the portfolio has already moved. Where the guardrails and percentage rules respond to what already happened, CAPE responds to what’s likely to happen. That’s a meaningful difference.
Strengths and honest weaknesses
The strengths: it’s the most responsive to actual risk of any rule here, it can safely support a higher rate in cheap markets (rather than leaving the low-valuation retiree needlessly frugal, as a flat rule does), and it’s grounded in one of the more robust empirical regularities in finance. Intellectually, it’s the closest thing to “right” the field has.
The weaknesses are equally real. CAPE is a weak short-term predictor — it has been elevated for long stretches during which markets kept rising, so a CAPE rule can tell you to under-spend for years while the good times roll, which is its own kind of regret. It’s more complex, requiring you to source the CAPE figure and run the formula. The parameters aren’t settled — reasonable people choose different constants, and the answer you get depends on them. And there’s a live debate about whether CAPE’s historical relationships still hold, given structural changes in accounting, interest rates and market composition; the average CAPE of the last thirty years is higher than the century before it, so “expensive relative to history” is a moving judgement. It’s a strategy that rewards understanding rather than blind faith.
Who it suits, and bringing the series home
CAPE-based withdrawals suit the engaged, numerically comfortable retiree who wants their spending to reflect reality rather than a fixed assumption — someone willing to trade simplicity for a strategy that genuinely earns its keep by tightening when risk is high. It pairs especially well with the flexibility strategies: use CAPE to set a sensible starting rate given the valuations you actually retire into, then run guardrails or a floor-and-ceiling on top to handle the year-to-year.
And that pairing is the real lesson of this whole series. There is no single best withdrawal strategy — there’s a dial between a steady income and a durable portfolio, and each strategy we’ve covered is a different, defensible setting on it: constant-dollar and percentage at the poles; guardrails, dynamic spending, the actuarial methods and endowment smoothing in the flexible middle; and the structural approaches — buckets, ladders and annuities — that sidestep the dial by guaranteeing the floor. The right answer is the one whose trade-off you can actually live with, in income and in temperament.
The only way to know which that is, is to see each one run against your portfolio, your spending and your horizon — not a textbook’s. That’s what Strata’s planning tools are for: pick a strategy (fixed dollar, fixed percentage, guardrails, floor-and-ceiling, variable percentage), and watch it play out across thousands of market sequences, with a withdrawal-phase survival test that shows you not a comforting single number but your real odds. A strategy you’ve watched behave on your own numbers is worth ten you’ve only read about. If you’d like to stop reading about withdrawal strategies and start testing them against your actual money, you can build your portfolio and run the whole tour for yourself.