JWR1945 ***** Legend
Joined: 26 Nov 2002 Posts: 1697 Location: Crestview, Florida

Posted: Fri Mar 19, 2004 9:01 am Post subject: Misjudging Safety 


This is a new way of looking at what happens if you misjudge a retirement portfolio's safety at different valuations. This is not my preferred method. But I think that it is always valuable to look at the same issue in a variety of ways.
Remember that we cannot look at today's valuations directly since they are outside of the range of the calculators (the Retire Early Safe Withdrawal Calculator and the FIRECalc). There have been no complete historical sequences that start at today's valuations.
I have put together three tables grouped according to P/E10. (You have seen tables like this before.) I put the latest Historical Database Rates for HDBR50 and HDBR80 into the tables. Those are the rates in 19211980 that would have survived 30 years but which would have failed if the withdrawal rate were increased by 0.1%. HDBR50 is for 50% stocks and 50% commercial paper. HDBR80 is for 80% stocks and 20% commercial paper. Both portfolios are rebalanced annually at no cost. [I used 0.20% for the expense ratio. I used $100000 to minimize truncation and/or rounding errors. Otherwise, I have left things at their default values. These data were collected by using the Retire Early Safe Withdrawal [Rate] Calculator, version 1.61, dated November 7, 2002. It can be used asis and/or with any of my modifications.]
I identified the Historical Database Rates extremes for each table (for both HDBR50 and HDBR80). Finally, I found out how many retirement portfolios (out of 60) would have survived at each extreme.
Remember that, although Historical Database Rates and P/E10 are closely related, there is randomness. They do not have exactly the same order. If you select the lowest percentage from the table with the lowest valuations, you are guaranteed that at least 20 (out of 60) portfolios would have survived. But there are some portfolios from the other tables that would have survived as well.
For example, with 50% stocks (HDBR50) the worstcase rate in the table with the lowest valuations was 5.1%. All of the (twenty) portfolios in that table survived at 5.1%. Sixteen from the other tables survived as well. A total of 36 (out of 60) portfolios would have survived and the remaining 24 would have failed within 30 years. One even failed at 20 years.
Here is my summary information using HDBR50:
Low valuation extremes:
At 8.1%, there were 42 failed portfolios at 20 years and 59 failed portfolios at 30 years.
At 5.1%, there was 1 failed portfolio at 20 years and 24 failed portfolios at 30 years.
Middle valuation extremes:
At 7.1%, there were 29 failed portfolios at 20 years and 48 failed portfolios at 30 years.
At 4.4%, there were 0 failed portfolios at 20 years and 6 failed portfolios at 30 years.
High valuation extremes:
At 5.5%, there were 8 failed portfolios at 20 years and 29 failed portfolios at 30 years.
At 3.9%, there were 0 failed portfolios at 20 years and 0 failed portfolios at 30 years.
Here are the results using HDBR80:
Low valuation extremes:
At 10.3%, there were 13 failed portfolios at 10 years, 45 failed portfolios at 20 years and 59 failed portfolios at 30 years.
At 6.6%, there were 0 failed portfolios at 10 years, 18 failed portfolios at 20 years and 29 failed portfolios at 30 years.
Middle valuation extremes:
At 9.5%, there were 7 failed portfolios at 10 years, 42 failed portfolios at 20 years and 54 failed portfolios at 30 years.
At 4.8%, there were 0 failed portfolios at 10 years, 0 failed portfolios at 20 years and 12 failed portfolios at 30 years.
High valuation extremes:
At 5.8%, there were 0 failed portfolios at 10 years, 13 failed portfolios at 20 years and 22 failed portfolios at 30 years.
At 3.9%, there were 0 failed portfolios at 10 years, 0 failed portfolios at 20 years and 0 failed portfolios at 30 years.
From this information, we can see what would have happened to someone who thought that he was preparing for high valuations but did not. If he really retired in the middle range, for example, he would have had 6 chances of failure (out of 60) using 50% stocks. That is 10%. If he had prepared for the high value extreme with 80% stocks but really retired from the middle range, he would have had 12 chances of failure (out of 60). That is 20%.
The reason that having 80% stocks looks so bad is that the retiree feels safer and would have withdrawn at a 4.8% rate. If he had selected 50% stocks, he would have withdrawn at a 4.4% rate. This shows the disastrous effect of overconfidence.
Have fun.
John R.

