These are some early results from the modified Retire Early Safe Withdrawal Rate calculator that I have described on a previous thread:
The portfolios that I have examined contained stocks (i.e., the S&P 500 index) and (hypothetical) Treasury Inflation Protected Securities (TIPS). I set the withdrawal rate at 5.0% to assure enough failures to produce meaningful data for analysis. I left the expenses at their default rate of 0.20%. I looked at stock allocations of 80%, 50% and 20%. P/E10 levels of 12, 15 and 18 were used for switching allocations. I set the threshold to 50 for collecting baseline data. There is no switching at such a high threshold.
I set the interest rate of the TIPS at 3.0%, which produces 2.8% interest after expenses. Setting this interest rate carefully is critical in making any analysis. During the historical period, even in times of low market returns, stocks yielded 3% or more in dividends. Any investment vehicle with a lower interest rate has been at a severe disadvantage when compared to stocks. When we try to project our Historical Database Rate results onto today's stock market, there is a dangerous mismatch of dividend yields. The key feature of dividends is that they are stable and well behaved when compared to stock prices. High dividend yields mean that you do not have to sell very many shares of stock when prices are low. Low dividend yields mean that you may have to sell heavily at depressed prices and that is what kills retirement portfolios.
By setting the interest rate at 3.0%, I have introduced an investment that would have matched the dividend-only return of stocks when valuations were high but that would not have the price volatility of stocks. It is possible to buy long term TIPS in the secondary market at interest rates close to 2.8%. Since owning them should cost much less than owning a stock fund, I have ignored their expenses. Since today's market offers very little in dividends, this analysis tends to downplay the advantage of switching into TIPS during times of high valuation.
In addition, the 30-year Safe Withdrawal Rate of 2.8% TIPS is slightly above 4.9%. Setting the interest rate of the TIPS at 3.0% (with 0.20% expenses) not only matches dividend yields but it also matches the selected withdrawal rate.
I have restricted my analysis to portfolios beginning in 1921 and later. There is an anomaly associated with earlier years. I have included partially completed sequences because they include portfolio failures. As a practical matter, portfolios started after 1974 have not had enough time to fail.
Data Summary
These are the number of portfolios that failed (starting on or after 1921) within 30 years and within 40 years.
Portfolio allocation: 80% stocks at low P/E10 levels and 20% stocks at high P/E10 levels.
Code: Select all
Threshold 30 years 40 years
12 0 10
15 11 14
18 1 8
Code: Select all
Threshold 30 years 40 years
12 0 12
15 10 14
18 4 12
Code: Select all
Threshold 30 years 40 years
12 4 10
15 8 11
18 7 11
Code: Select all
Stocks 30 years 40 years
20% 11 32
50% 9 16
80% 13 18
The middle level threshold (of 15) appears to interfere with switching. You appear to be better off by loading up on stocks when prices are low and they are bargains. Alternatively, you can do very well by holding onto stocks until prices are high and valuations are dangerous. Trying to do both at the same time does not work.
Remember that the calculator has only one threshold and you can only choose between two allocations. Remember as well that the threshold has no memory. It does not consider whether prices are trending up or trending down.
Looking at the baseline results shows what happens when the stock allocation is very low. TIPS could provide almost 30 years of income at a withdrawal rate of 5%, but not any more. It would be slightly less. Stocks are needed to extend the portfolio life span. They provide long-term growth.
Comparing the 80% and 20% portfolio with the 50% and 20% portfolio, it is a good idea to load up on stocks when prices are below threshold, especially at the lowest threshold.
Comparing the 80% and 20% portfolio with the 80% and 50% portfolio, making the bigger change (to 20% instead of 50% stocks) at high valuations looks better.
In terms of whether switching works, look at the data when there is no switching. In every instance there are 9 or more failures in 30 years. If you look at the cases in which you cut back stocks to 20% above threshold, you can find instances with very few failures. Look at the thresholds of 12 and 18, not the intermediate level. In terms how results have been reported in the past, the claim could be made that cutting back to 20% stocks when P/E10 is above 12 produces 100% safety over 30 years. You would have your choice of a stock allocation of either 50% or 80% when P/E10 is lower than 12.
That is, the traditional claim would have been that 2.8% TIPS (after expenses) plus switching (at P/E10 = 12) provides a safe withdrawal rate of 5.0% (with 100% safety) over 30 years. That is certainly the Historical Database Rate result. I would not use it as a safe withdrawal rate because we are outside of the historical range in terms of both valuations and dividends.
Have fun.
John R.