Does VII work?

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Re: Does VII work?

Postby Schroeder » 02/15/08 at 19:15:08

Schroeder wrote:But getting back to the problem of simulating a reasonable tax treatment, here's one idea. For gains generated during holding periods shorter than 1 year, use a 30% tax rate. And for gains generated during holding periods longer than 1 year, use a 20% tax rate. If anyone has better ideas, feel free to chime in.

I forgot about taxes on bond interest. This should be easy. Just use the same tax rate as on short-term capital gains: 30%. So, for example, if you received, say 5%, in bond interest, you would get to keep only 3.5%.

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Re: Does VII work?

Postby hocus » 02/16/08 at 13:00:05

Wonder which song lyrics he'll decide to use in response!

There's one sort of hidden in there.

Bruce Springstein has an unreleased song called "From Small Things, Mama, Big Things One Day Come." Someone else recorded it and I heard it on a collection of covers of Springstein songs entitled "Cover Me." I used that line in one of my responses.

None of the stuff on which Frank Sinatra is the leading authority has come up yet. You can't force this stuff. Nice 'n easy does it everytime.

Oops!

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Re: Does VII work?

Postby nfs » 02/16/08 at 17:00:00

Schroeder wrote:
But getting back to the problem of simulating a reasonable tax treatment, here's one idea. For gains generated during holding periods shorter than 1 year, use a 30% tax rate. And for gains generated during holding periods longer than 1 year, use a 20% tax rate. If anyone has better ideas, feel free to chime in.

Schroeder

Schroeder, I suspect you're not going to see anything that you like.  I haven't got the time today to add all the cost basis tracking but here's a good indicator of why taxes aren't going to help much.  If I swap out the sliding scale VII I used in my simulation for the 30/60/90 VII, the number of buy/sell transactions goes from 150 over the 80 year period to just 68 (B&H did 58 rebalancing transactions).  Plus some of those trades are quick sequences of sell (because e.g. PE10 goes to 19.03) and then a buy the following month (because PE10 falls back under 19).  If I pull out those flutters, which only requires a small modification to the idea (like buy/sell if two consecutive months are on the wrong side of a PE10 threshold), then VII ends up with only 50 trades in 80 years, less than B&H.  Fewer transactions, likely more taxes because of the way it should work, but I don't think there's a lot of joy for B&H in this idea.
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Re: Does VII work?

Postby hocus » 02/16/08 at 17:26:20

here's a good indicator of why taxes aren't going to help much.

This comment suggests that there are people (Schroeder for sure, possibly NFS too) who would like to see VII not work.

Why?

It's a win/win/win for investors to learn that it is possible to predict long-term returns with a reasonable amount of accuracy. Absolutely nobody loses.

This feeling certainly exists. There is no question whatsoever about it. But it is truly a strange phenomenon.

People are praying for bad news just because they find the good news surprising.

Yowsa!

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Re: Does VII work?

Postby Schroeder » 02/16/08 at 18:08:32

nfs wrote:
Schroeder wrote:
But getting back to the problem of simulating a reasonable tax treatment, here's one idea. For gains generated during holding periods shorter than 1 year, use a 30% tax rate. And for gains generated during holding periods longer than 1 year, use a 20% tax rate. If anyone has better ideas, feel free to chime in.

Schroeder

Schroeder, I suspect you're not going to see anything that you like.

Don't worry being the bearer of good or bad news. ;)

I notice that you neglected to comment on my second request to apply a 30% tax rate on bond interest. Hiding in bonds does not come free in the real world.

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Re: Does VII work?

Postby Yipee-Ki-O » 02/16/08 at 18:22:28

It appears from nfs' graphs that VII worked fairly well in the distant past and less well in the recent past. He (nfs) suggests that possibly some recency bias may have impacted the more recent returns for B&H. While it may be interesting to ponder the "how and why" of what the graphs represent (as seemed to be taking place at the Financial Webring Forum prior to the outbreak of hocorrhea), in the end it will be of little value to an investor of the Boglehead's persuasion. For hocus and JWR, the stock market begins and ends with the S&P 500. But central to the Bogleheads philosophy is the concept of diversification across several different asset classes. When the S&P 500 represents only a relatively small portion of ones equity allocation, it's questionable whether it makes sense to expend much effort in adjusting the allocation of that portion according some valuation formula. The act of rebalancing alone should be sufficient to harvest any temporary "overvaluation" of any particular asset class. If ones portfolio consists solely of bonds and the S&P 500 Index, VII might be worth looking into. However, it seems to offer little actionable information to one using a diversified asset allocation strategy.
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Re: Does VII work?

Postby Schroeder » 02/16/08 at 18:25:05

hocus wrote:This comment suggests that there are people (Schroeder for sure, possibly NFS too) who would like to see VII not work.

Why?

Just to make my views clear. I don't consider myself dogmatic on B&H. Evidence that I have mentioned tactical asset allocation. Bogle also mentions this in his books and suggests no more than 15% shift away from one's long-term stock allocation. I view this as a nice compromise if someone wishes to change their stock allocation in response to changes in valuations.

My other comment is that we may have seen a permanent elevation of P/E10 levels. P/E10 level of 20 may be the lower boundary going forward. I find it highly doubtful that we'll see P/E10 much lower than 20 anymore.

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Re: Does VII work?

Postby hocus » 02/17/08 at 04:20:56

I don't consider myself dogmatic on B&H.

There is nothing more dogmatic than favoring a ban on honest posting on the question, Schroeder. That is the most extreme position imaginable.

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Re: Does VII work?

Postby hocus » 02/17/08 at 04:27:22

My other comment is that we may have seen a permanent elevation of P/E10 levels. P/E10 level of 20 may be the lower boundary going forward. I find it highly doubtful that we'll see P/E10 much lower than 20 anymore.

This is a viewpoint. It is the purpose of our boards to facilitate the expression of such viewpoints. It is also the purpose of our boards to faciliate the expression of alternative viewpoints.

It is certainly not "100 percent safe" for people to plan retirements pursuant to your particular viewpoint without even being made aware that there are alternatives held by many people who have spent a great deal of time studying these questions.

Any board that prohibits the discussion of the alternative viewpoint, knowing that people are using what is said at the board to plan retirements, is a corrupt enterprise.

That is not a viewpoint. That's a fact that cannot be denied by any reasonable person.

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Re: Does VII work?

Postby Schroeder » 02/17/08 at 09:38:12

I had another thought on this . . .

nfs wrote:If I swap out the sliding scale VII I used in my simulation for the 30/60/90 VII, the number of buy/sell transactions goes from 150 over the 80 year period to just 68 (B&H did 58 rebalancing transactions).

You mentioned that you are using monthly data. So do you rebalance on a monthly basis or an annual basis? VII has specific triggers when to change allocations, so that can remain on a monthly basis. But most B&H'ers don't usually rebalance more frequently than every 12 months unless short-term changes in prices drastically change their allocations. So maybe consider rebalancing the B&H portfolio only if the stock allocation exceeds 65% on the high side and 55% on the low side. That should cut down on the number of buy/sell transactions for the B&H portfolio.

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Re: Does VII work?

Postby hocus » 02/17/08 at 12:06:27

VII has specific triggers when to change allocations

This is of course a false statement.

The goal of VII is to "Stay the Course," that is, to keep one's risk/reward profile roughly stable.

How many transactions the investor wants to engage in is up to the investor, as it is when an investor follows a rebalancing strategy.

Some investors following a rebalancing strategy rebalance frequently, some not so frequently. It is up to the individual. It's the same with VII.

The difference is that those following VII aim to "Stay the Course" in a meaningful way. The goal is not to keep the stock percentage roughly constant, but to keep the risk/reward profile roughly constant.

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Re: Does VII work?

Postby Schroeder » 02/17/08 at 13:17:45

hocus wrote:VII has specific triggers when to change allocations

This is of course a false statement.

The goal of VII is to "Stay the Course," that is, to keep one's risk/reward profile roughly stable.

How many transactions the investor wants to engage in is up to the investor, as it is when an investor follows a rebalancing strategy.

Some investors following a rebalancing strategy rebalance frequently, some not so frequently. It is up to the individual. It's the same with VII.

The difference is that those following VII aim to "Stay the Course" in a meaningful way. The goal is not to keep the stock percentage roughly constant, but to keep the risk/reward profile roughly constant.

Rob

I don't see where we are in disagreement. You say, yourself, that the goal of a VII investor is not to keep the stock percentage constant. So how is a VII investor supposed to describe when he changes his stock percentages? In my mind, the way to do this is to set trigger levels. You even offered a set of trigger levels earlier this this thread . . .

hocus wrote:A very simple way to test it would be to go with 80 percent stocks for years with a starting P/E10 of up to 19 and with 20 percent stocks for years with a starting P/E10 of 19 and above.

And here's another set of trigger levels you mentioned . . .

**LINK**
If you force me to give one rule on how to implement VII, I would say consider going with a 30 percent stock allocation when the P/E10 value is above 19, a 60 percent allocation down to a P/E10 of 12, and a 90 percent allocation for P/E10 values below 12. However, I reserve the right to change those rules as I continue to work the calculators and build new ones and learn more about this approach. This is new to me too, you know.

And giving this particular quote a second a read, I find it curious that you say that "this is new to me too." Is VII just an airy-fairy concept for you, hocus? You are the most informed proponent of VII. If you dont have fairly good idea how an investor is supposed to implement the VII strategy, how can you expect anyone else not familiar with the mechanics (i.e. trigger levels and such) to implement it?

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Re: Does VII work?

Postby hocus » 02/17/08 at 15:56:34

In my mind, the way to do this is to set trigger levels.

That's one way to do it. It's not the only way.

Does everyone who rebalances set "trigger levels" for rebalancing? That sure is not my impression.

Some do, some don't.

It's the same with VII.

If you want to make frequent changes, you can do it that way. If you want to avoid fees, you can do it that way.

It's up to the individual investor how he implements the concept. All that the concept requires is that the investor make efforts to "Stay the Course" in a meaningful sense (by keeping his risk/reward profile roughly constant).

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Re: Does VII work?

Postby hocus » 02/17/08 at 16:06:44

Is VII just an airy-fairy concept for you, hocus?

No. I've written about it extensively.

If you dont have fairly good idea how an investor is supposed to implement the VII strategy, how can you expect anyone else not familiar with the mechanics (i.e. trigger levels and such) to implement it?

It's a new idea. We have not yet done extensive research into the question of how best to implement it. As I learn new things, I report on them in articles at my web site.

Each investor needs to decide for himself or herself how to implement the concept.

I have heard from numerous people who have had no difficulty in figuring out how to implement it. I have also heard from some who have expressed uncertainty on how to implement it.

I have put forward guidance in response to questions that have been sent to me. But I obviously cannot put forward guidance on questions for which I do not know the answers. I do not know today what is precisely the best way to implement VII in every circumstance.

My opinion is that this question will likely never be answered in a definitive sense any more than the question of what is the best stock allocation can ever be answered in a definitive sense. There are too many factors to be considered for there ever to be one answer that applies to all investors and to all circumstances.

I do expect that we will learn more as time goes on. I feel that today we are in the middle innings of the ballgame. We know much more than we knew six years ago. But I expect that we still will be learning more six years from today.

It seems absurd to me that there is anyone who somehow came to expect different. How long has it been that people have been studying investing? Hundreds of years. And you expect the Retire Early Community to come up with the answer to every question in six years? It's not a reasonable expectation.

We will continue to learn. Good for us! That's why the community was founded in the first place. Our boards were intended to serve as learning resource.

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Re: Does VII work?

Postby Schroeder » 02/17/08 at 16:18:39

hocus wrote:All that the concept requires is that the investor make efforts to "Stay the Course" in a meaningful sense (by keeping his risk/reward profile roughly constant).

Rob

If you repeated these words on the Boglehead's forum . . .

All that the concept requires is that the investor make efforts to "Stay the Course" in a meaningful sense (by keeping his risk/reward profile roughly constant).

. . . no one would argue with you because they take "keeping risk/reward profile roughly constant" as maintaining a constant stock allocation. However, we both know that your definition of "Staying the Course" (changing one's stock allocation in response to changing valuations) is different from everybody else's.

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