A Recent Email Exchange

Research on Safe Withdrawal Rates

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JWR1945
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A Recent Email Exchange

Post by JWR1945 »

One of the advantages of having hocus back is that we can get more of the human element into these posts. I have extracted this from the end of a recent email exchange. Rob had asked a question to help clarify the latest research in his own mind. It help clarify my thinking as well. There were several steps before reaching this stage.

Rob,

We may be in a version of scenario A but things will turn out just fine anyway!

"If Investor A and Investor B both use the tool to determine the SWR assuming a 4 percent annualized return for the first 10 years, and Investor A is in stocks at the beginning and Investor B is not in stocks but plans to get into stocks at the end of 10 years, there are three possibilities: A will be ahead at the end of 10 years; A and B will be even at the end of 10 years; or B will be ahead. The only problem scenario is A [the first]. The only way that B's approach could fail is if the last 20 years provided terrible stock returns and it was the big gains that A experienced in the first 10 years that pulled him through."

The bubble (with dates carefully chosen) probably produces this kind of result. Think in terms of when Professor Shiller first wrote "Irrational Exuberance." Remember that those days also produced 4% TIPS. Safer investments had to provide outstanding returns because of their competition from stocks.

We could have bad returns for high stock portfolios lasting until 2015 or so. Even if that were to happen, I would expect to see good buying opportunities no later than 2010. The market tends to make dramatic moves, both upward during bear markets and downward during bull markets. Among those buying opportunities will be some outstanding bargains starting around 2010. [All of this is a guess, of course. It just seems likely. It will take some time for valuations to return to their historical range.]

If I am right in this assessment, the only thing that the worst case really brings about is embarrassment when people make comparisons, not recognizing the importance of luck in such situations. Attractive safe alternative investments assure that B's approach still succeeds.

Have fun.

John Russell
Mike
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Post by Mike »

We could have bad returns for high stock portfolios lasting until 2015 or so.
We could have bad returns longer than that, if we have good returns for the next few years that drive valuations even higher than they are now. We have not identified the factors that have driven valuations higher with sufficient precision to guess at when they might reverse.
Mike
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Post by Mike »

The only way that B's approach could fail is if the last 20 years provided terrible stock returns and it was the big gains that A experienced in the first 10 years that pulled him through."
The last 10 years have provided stellar returns for equity. Anyone who retired 10 years ago with an equity portfolio has gains that are probably sufficient to carry them through. A fixed income investor would still be waiting for compelling equity valuations to invest, with the possibility of waiting another decade. I have to ask myself what has changed. Even the post Y2K tech bust was not able to turn the tide, despite earnings falling in half for a while.
peteyperson
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Re: A Recent Email Exchange

Post by peteyperson »

John,

What makes you say that equities will fall around 2010 and things will be cheap around 2015? Are you thinking because the baby boomers who saved will be selling to change their asset allocation at that time?

It is certainly true that buying great companies at less than the average PE multiple offers the opportunities for two bites at the return cherry (one from growth in earnings, the other from later PE expansion). My planning on stocks at today's prices mean that I would perform the opposite calculation and account for a possible PE contraction. I might use a grid with the buying price, PE multiple, three earning growth estimates, the ending earnings per share, the final PE multiple, final share price and annualised return. This would allow for the imprecision of projecting out earnings ten years ahead as well as the reality that I may sell out of a position if the business changes materially or I may sell down gradually living off the investment piecemeal and such sales will be performed ultimately at a range of different PE multiples over many years. Buffett did so well in the 1970s and early 1980s because he was able to buy equities on the cheap when most were selling worried when equities would ever rebound. The double dip helped push his results into the 20% annualised range.

Personally I am unlikely to be invested until 5 years or so, so I won't be in the market till close to 2010 anyway. I really cannot predict what the PE multiple will be around 2020/30 when I hit age 49/59, but it is worth doing the above calculations to examine a range of return estimates taking into account PE multiples. That said, the main focus should be on finding businesses with substainable models, offering compelling products and healthy growth prospects. This provides for the highest annualised return regardless of the final PE multiple (of range of PE multiples) I receive upon selling my position.

Petey
JWR1945 wrote:One of the advantages of having hocus back is that we can get more of the human element into these posts. I have extracted this from the end of a recent email exchange. Rob had asked a question to help clarify the latest research in his own mind. It help clarify my thinking as well. There were several steps before reaching this stage.

Rob,

We may be in a version of scenario A but things will turn out just fine anyway!

"If Investor A and Investor B both use the tool to determine the SWR assuming a 4 percent annualized return for the first 10 years, and Investor A is in stocks at the beginning and Investor B is not in stocks but plans to get into stocks at the end of 10 years, there are three possibilities: A will be ahead at the end of 10 years; A and B will be even at the end of 10 years; or B will be ahead. The only problem scenario is A [the first]. The only way that B's approach could fail is if the last 20 years provided terrible stock returns and it was the big gains that A experienced in the first 10 years that pulled him through."

The bubble (with dates carefully chosen) probably produces this kind of result. Think in terms of when Professor Shiller first wrote "Irrational Exuberance." Remember that those days also produced 4% TIPS. Safer investments had to provide outstanding returns because of their competition from stocks.

We could have bad returns for high stock portfolios lasting until 2015 or so. Even if that were to happen, I would expect to see good buying opportunities no later than 2010. The market tends to make dramatic moves, both upward during bear markets and downward during bull markets. Among those buying opportunities will be some outstanding bargains starting around 2010. [All of this is a guess, of course. It just seems likely. It will take some time for valuations to return to their historical range.]

If I am right in this assessment, the only thing that the worst case really brings about is embarrassment when people make comparisons, not recognizing the importance of luck in such situations. Attractive safe alternative investments assure that B's approach still succeeds.

Have fun.

John Russell
JWR1945
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Posts: 1697
Joined: Tue Nov 26, 2002 3:59 am
Location: Crestview, Florida

Post by JWR1945 »

I have posted my comments separately in A Bright Future and The Facts about Hocus's Investment Decisions.

They reference my original calculations and equations as well.

As for my time estimates: the historical periods of multiple expansion and contraction have been approximately 26 years total. To go from high to low would take 13 years. These periods are only rough approximations and we have very few cycles in the historical record.

There are usually some opportunities of the order of 2 to 3 years both before and after any trend. They are not guaranteed.

You can wait 20 or 30 years if need be.

Have fun.

John R.
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