B. Valid assumptions are not always good ones.
C. A perfect model with perfect assumptions is rarely valid over the long term.
First, thanks to all that have participated and posted in this board on the subject of SWR. The postings are quite informative and insightful. We were set to visit in open discussion about our research on the financial markets next week. Since it has been postponed, I'd like to offer a few comments to assist all in the consideration of the issues that have been raised. As well, based upon a solid investigation of SWR, there are a few additional comments. 'Hocus', 'JWR1945', and others are right: valuation does matter toward future returns in the stock market. For what it's worth, valuation always affects future returns in any financial instrument or model (by definition). If you'll read on, there are other issues that matter more...
There has not been an extended period over the past century or more when history can be said to fully repeat itself. Said another way: if an analyst had used historical data before 1950 or before 1975 or before 2000 to estimate what could have been expected over the subsequent 25 years or so, the forecasted scenarios would not have happen exactly as expected. Several key considerations to consider about the using the historical data since the late 1800's as the full analysis set:
1. Prior to the 1960's, interest rates and inflation were not aligned and were inconsistent - after 1960 or so, the relationship is much more consistent (as one would expect fundamentally). [see http://www.crestmontresearch.com/pdfs/i ... onship.pdf]
2. P/E ratios relate to inflation, not to interest rates. This will explain some of the perceived anomalies over the past century. [see http://www.crestmontresearch.com/pdfs/S ... &%20PE.pdf]
3. Stock market returns tend to occur in cycles: P/Es rise when inflation heads toward price stability; EPS (earnings) are fairly constant with the economy over longer periods; therefore stock returns are dependant upon positive trends in P/Es (i.e. inflation trending toward 1%) and suffer when P/Es fall.
4. We are currently in a period of (a) high P/E valuations. (b) low interest rates, and (c) low inflation - significant "Vulnerability" for financial markets and securities. If inflation declines much further (deflation), P/E's will fall. If inflation rises, P/E's will fall as well. The prospects for significant gains in the stock market this decade are dismal (P/Es are likely to decline slightly as EPS increases, with a net result being a very choppy and relatively flat market).
5. CLOSELY NOTE: When using historical data about the stock market and cash returns (especially during the early 1900's), note the substantial dividend yield and cash returns (the commercial paper rate is used in some popular SWR models). Today, dividend yields and cash yields are significantly lower than the early part of the 20th century. High dividends and cash yields sustain a higher SWR. This was particularly true in the earlier parts of the 1900's and enables the hypothetical investor in SWR models to endure large market swings. Without the same level of current cash flow, the SWR models have significantly different results.
6. BIG PICTURE: SWR seems to be about how much a retiree can withdraw from savings without running out of principal over a prescribed long term period. If stocks are destined for mediocre returns (maybe none over the next decade or so) and other sources of income imbedded in the historical data (i.e. dividends, interest, etc.) are substantially less today, how can retirees hope to fund relatively higher withdrawals (4%+)?
7. Transaction Costs: the assumptions in most SWR models that I've evaluated assume index returns - without regard for transaction costs, asset management fees, commissions, bid/ask spreads, taxes, etc. There costs can be material - bake them in as well - and total transaction costs often run 1% to 3% annually or more.
8. Techniques: seek advice from an independent financial advisor about techniques to deal with non-trending markets. The stock and bond bull markets of the 1980's and 1990's were trending markets and benefited from "buy-and-hold" and "buy-on-dips" strategies. The next phase could be another secular bear cycle (see http://www.crestmontresearch.com/pdfs/S ... 0Chart.pdf). Note the difference in secular bull and secular bear periods. Ask your advisor about the effect of more frequent rebalancing, covered call option writing, higher yielding preferred stocks and other securities with higher current return, TIPS, hedge funds, and other risk-controlled and value-added investment strategies.
Please consider reviewing our research at www.CrestmontResearch.com relating to stock market cycles, long-term returns, and interest rate cycles. For each of the charts with links listed above, you'll find a brief description within the Stock Market and Interest Rate sections. We welcome your insights and perspectives to further the research. Our analysis is not above challenge: I welcome it. It has not gotten to were it is today without challenge. All along, I've hoped for rational insights that would support strong upside potential in the financial markets. To date, the results instead have been rather sobering. Our research is not intended to generate predictions; rather it is intended to be provocative and enlightening. Hope it's helpful; there's no cost and it's free of banner ads. I welcome your comments, questions, and persepctives either in reponse to this posting or through our website.
Unlike Bill Murray in "Groundhog Day", we don't get another chance to replay our retirement scenario. The risk for a retiree of an error in applying an SWR strategy is serious: you only find out that the assumptions were insufficient when it's too late to change the course. Accolades to all that are advancing these issues for their and others insights. SWR is a rational methodology for applying financial planning to long-term retirement using investments as the primary source of income - beware the assumptions.
hocus wrote:"The special event discussion with Ed Easterling on SWR-related issues, that had been scheduled for August 6, has been canceled.
It is my hope that the event will be re-scheduled for some later date"