Maybe I can add some insight here

Research on Safe Withdrawal Rates

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mannfm11
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Maybe I can add some insight here

Post by mannfm11 »

I read the P/E10 thread and I am not sure I follow it. But, I don't really care if I follow it exactly, because I have a good idea what you guys are trying to figure out. How do you quit working and continue to live reasonably well. My Dad quit work at 46 and he wasn't exactly rich, but he died at age 69 with a net worth of $800,000. He did nothing special except watch his money and keep his money in conservative assets. He died in early 1997 so he didn't exactly miss the bull market, was paranoid of being sued and hid well over $100,000 in a safe deposit box for several years, forgoing interest. He had roughly $100,000 in a mutual fund when he died and never made a withdrawal or addition to the fund, an asset he inherited. Being that he started with about $350,000 and took almost no risks, I know it can be done.

I think where you start is looking at where you have to spend money. If you are planning on living like a king, then most likely you aren't rich enough. If you have a reasonable place to live and no mortgage, that is a start. If you don't have a massive appetite for nice cars or you can drive one for 7 to 10 years before you go onto the next one, that is the next step. Eating and paying the moderate costs of property taxes doesn't cost that much in the USA. I don't know about England. Dad took long trips to Australia and New Zealand and Hawaii, South America the Caribean and central America. He didn't buy much, but again he could have worked another 4 or 5 years and really lived it up in retirement.

As far as how much money you can get out of stocks and not run out of money, I think I covered that in the first post I put up. I think stocks are the inferior asset at this time and if I was retired or thinking of retirement, I would choose another investment vehicle. If you insist on stocks, use this formula. Take the dividends on the SPX and divide them by trend inflation minus trend growth in dividends plus 6%. That formula would look something like this today. 18.50/(2.5%-3.5%+6%)=18.50/.05 or 20 times dividends. You might recognize this value as the approximate values Shiller came up with at the bottom of his spreadsheet. (Shiller sent me another spreadsheet that went to monthly values and acted like this one never existed. It disappeared for a couple of months after he wrote me and I would imagine he didn't want his work showing such a low value on the SPX). That figure is 370. What this figue presents is a failsafe way to never run out of money and stay up with inflation. For those of you that haven't noticed, this presents an 8% return on stocks and a return 6% above the rate of inflation. It is probably an undervaluation of stocks on a portfolio basis, but in general, the entire market should relate to this amount. If one wants to try growth stocks, they might use an 8% growth rate on a portfolio, but again, I wouldn't use over 20 times earnings.

What is presented here is you can take 6% of this valuation out of stocks. It is a 5% dividend rate and a 1% growth rate in excess of inflation. Theoretically, dividends should be 3.5% higher next year, meaning you could take $60 per thousand this year and be left with a portfolio worth $(1000 X 1.035)-$10=$1025 for next year. Next year, you would do the same calculation and pay out all dividends plus 1% of the portfolio value for trend real growth.

There is really no other way that one can use stocks and figure out the returns needed to keep one afloat against time and inflation. This is going to be a hard pill for stock holders to swallow and those that are smart and think they will live a long time will buy something like a life annuity with enough money to pay their living expenses and really be conservative with the rest of what they have. Remember, at current valuations, we are back to the 2% that I saw mentioned on this thread. At 4% growth, it would take 18 years to get to an 4% annual payout. As I said, this is going to be a hard pill to swallow for those that are trying to use stocks to retire.

What it appears to me is that people are trying to do the impossible. What you have to look at is the stocks you have are going to pay a dividend and the typical portfolio is going to provide an income that grows 1% in excess of inflation. You can either take the growth now and bank the inflation for a cost of living raise or you can leave it to compound and just take the dividend. But what are we looking for? If you want to hedge inflation, there probably isn't another way except to maintain some money in stocks. But, remember we are going to have a continued fight with deflation, not inflation. Stocks go in reverse in deflation or no inflation, as I believe that the growth above inflation is nothing more than leading inflation that companies bank on their bottom lines. What this means is an SPX fund with a minimal 20 bp management fee can pay you safely, on $300,000, $4230 and $3000 in growth, for a total of $7203 and there are still risks. This amounts to 2.41% on an annual basis and you get a cost of living raise every year that is going to relate to the rate of inflation. Should we go into a period of time where there is no growth over the rate of inflation or in fact the growth rate goes negative, the amount payable safely will actually go down.

Now comes the dreaded facts. If one has built up a sizable stock portfolio and wants to retire, lets take the same $300,000 we see above. Remember, this example above has you selling 1% of your stock every year to get the extra $3000 or your growth above inflation, something that isn't guaranteed. I have at my disposal insurance software, which will put out different payments for what someone might want to reproduce. I am about to show you where life insurance beats the stock market, something I have never tried before. Current trend inflation in the United States is around 2.37% based on the last 10 years and something that can be fairly well verified by the yield on 30 year bonds, roughly 3% above this rate. With a 3% inflation accellerator included, life income of $600 a month for a 55 year old male costs $149,363.44. If one wants to forgo the COLA, the stream costs you $105,848. This would leave you $4800 a year more cashflow out of your stocks hedged by inflation adjustments, meaning you can get the current income out of an annuity with 1/3 the amount of money or 1/2 if you want to replicate the inflationary gains. Growth and inflation are not guaranteed in either direction and the capacity of stocks to pay any return at all could very well collapse as it did in 2001 and in the period between 1929 and 1932. The COLA associated with the $149,363.44 purchase price is .63% above the current trend inflation.

The dreaded giving your money to an insurance company in this day and time could be the only salvation for early retirement. One could attempt to do the same thing with corporate bonds, but again we have the threat of default. Government bonds are paying about 5.25% on a 30 year basis and the needed income just cannot be had out of them to pay the current return and the 3% increase. I must also mention that 46.2% of the cashflow represents a return of principal and isn't taxable out of nonqualified funds. With a marginal boost in interest rates, the payments would increase. We aren't exactly dealing with a good climate for payments on the receiving side in any fashion.

I don't put a lot of emphasis on PE ratios because I highly doubt the ability of the corporate world to sustain earnings and I doubt the quality of the earnings. I know there are stocks that don't pay dividends, but they really have only imaginary until they do and can show a track record. I sense there is massive risk in the stock market and companies like General Motors, who pay a sizable dividend represent a highly speculative investment in todays overleveraged climate. The governments of the world might bail out part of GM, but I doubt the stockholders are going to be left intact if they do.

I believe what John showed in the post on the top tells all. Stocks represent a good option for retirement income when PE ratios are low and dividend payments are high. We are looking at a market that is priced at over 60x dividends and there isn't a lot one can do to imagine a stream of income that will change this fact. Dividends have historically been between 40% and 60% of earnings, making me believe the current 20X that is being mentioned on the SPX is a pipe dream. The world is full of over capacity and it is highly doubtful companies need over 2/3rds of their profits for expansion. I doubt the wisdom of stock buybacks, as the cheapest capital a company has today is dividends and not highly priced stock and debt. High stock prices are almost solely for the benefit of speculators and insiders, when looked at on an investment basis. There is no investment benefit out of holding an overpriced asset.
JWR1945
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Post by JWR1945 »

Thank you for three great posts, mannfm11. It will take a little time for me to work through all of them. Here are some bits and pieces in response to your post on this thread.

I want to be extra sure that I understand exactly what you are saying in all instances.

We usually refer to real dollars (i.e., after adjusting for inflation) as opposed to nominal dollars. I believe that you generally present nominal dollars and then make an inflation adjustment.

When I read your equation for the value of the SPX (S&P500 index), I believe that you are referring to something similar to this:
a) From William Bernstein's The Four Pillars of Investing on page 54, we read the Gordon Equation: Return = Dividend Yield + Dividend Growth.
b) Using dollars after inflation, this translates to the real long-term growth of the stock market = 6% = required dividend yield + 1.1% real dividend growth over the very long-term (50+ years).
c) In your formula, you use a rounded 1% for the real dividend growth rate.
d) Using these values, a reasonable price is the current dividend amount divided by the required dividend yield. This corresponds to your numbers. Your calculation was 18.50/(6% - 1%) = 370.
e) The latest dividend entry that I saw while visiting Professor Shiller's web site was $16.01 in June of 2002. It is reasonable to think that the dividend amount has increased to $18.50 since then.

When I make adjustments based on P/E10, I treat the earnings component as fixed (since the average of the previous ten years of real earnings does not vary rapidly). The latest value of P/E10 was P/E10 = 25.898702 as of November 2003. The index level was 1054.87. The S&P500 index is in the neighborhood of 1140 today. Today's P/E10 is close to (old P/E10)*(new price/old price) = (25.898702)*(1140/1054.87) = 27.988776 or almost exactly 28.0.

The typical or fair historical value of P/E10 is about 14 or 15. That means that today's prices are high by a factor of two. Using this approach, the typical or fair historical value of the S&P500 index should be 570. Your number of 370 corresponds to a P/E10 level of (370/1140)*28.0 = 9.1, which would be a bargain price, but a realistic bargain price historically.

OTOH, your numbers extend into an indefinite future. That suggests that your numbers should lower than mine.

Again, these are only a few bits and pieces. I will continue to study your posts.

Thanks. Have fun.

John R.

P.S. I can provide lots of information from Professor Shiller's data because of some data reduction modifications that I have made to the Retire Early Safe Withdrawal Calculator. This includes nominal and real balances and annualized rates of returns at any level of dividend reinvestment and with a considerable amount of flexibility in making withdrawals (or additions) to the balances.
bpp
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Post by bpp »

Hi mannfm11,
The dreaded giving your money to an insurance company in this day and time could be the only salvation for early retirement. One could attempt to do the same thing with corporate bonds, but again we have the threat of default.
Since you work in insurance, can you give some evaluation of what the risk of failure of the insurance company might be? This is something people worry about here in Japan, and I wonder if people have similar concerns in the US. The "disaster" scenario I can envision, even if the economy were booming, is that the insurance company issues a bunch of annuities based on current actuarial tables, and then medical science comes up with a cure for death or something. (Or less dramatically, maybe they cure cancer, or learn to suppress programmed cell death, or something else that suddenly extends life expectancies significantly.) What happens then?

I like the annuity idea in principle, and even have a bit of money going into a deferred annuity myself (though to be honest, I signed up for it before I learned about investing, and might not sign up for it today if I hadn't already). But I do consider it kind of a risky thing, and not at all a replacement for ordinary investments. More of a complement to them.

Bpp
Mike
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Post by Mike »

...then medical science comes up with a cure for death...
I was talking about this topic the last year that I worked with several of my coworkers. I was stunned to hear more than one person tell me that they didn't want a cure for death, because it meant that they couldn't retire when they got their 30 years in. I couldn't believe what I was hearing. I told them that they needed to make some serious changes in their lives.
mannfm11
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That was very funny Mike

Post by mannfm11 »

your comment about being able to retire after 30 years
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