Switching with Small Cap Value Stocks

Research on Safe Withdrawal Rates

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JWR1945
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Post by JWR1945 » Thu Feb 03, 2005 11:33 am

For MacDuff,

Thank you for your kind words and thank you for asking questions.

Your questions help us tie everything together. Questions can point to new areas of research as well. They are very valuable.

The last time that I tried to write a summary was in the May 2004 Overview post with a sticky near the top of the contents page. It is amazing how much we have advanced in our thinking since then.

Have fun.

John R.

peteyperson
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Post by peteyperson » Thu Feb 03, 2005 11:57 am

Hi MacDuff,

I would say your interpretation is about right. The suggested model adjusts for valuations because that is really what it is aiming to do. Selling down asset classes that offer poor future real returns by merit of the high P/E at the time. I can do this manually for the UK large stock or total market index, as well as for the UK and continental Europe. They all show the same thing. Close to zero percent real return for 1-2 decades until overvaluations stops hurting the real returns. Only value style will boost those returns to positive numbers reliably.

Often investors do not think as owning as being the same as buying. But in fact it is. You are getting the same forward returns holding an existing position as you are buying a new one. If one wouldn't choose to buy today, one shouldn't continue to hold unless one has tax reasons for doing so or there are no better choices currently available.

Petey

MacDuff wrote:Let my check this understanding with you. The fixed or non-switching allocations show no adjustment for S&P 500 levels. This is just the baseline, the system that is being used as a control.

However, by it's very nature, the variable allocation system dynamically adjusts for valuation. For example, at today's level on the S&P, one would assign a 0 allocation to any equity position that you were timing based on the S&P. (ie. equity groups that were highly enough correlated with S&P to use Shiller's existing S&P data.

Is this accurately stated?

Thanks for your response to my other question above.

Mac

peteyperson
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Post by peteyperson » Thu Feb 03, 2005 12:07 pm

Hi John,

Just thinking about this, I would assume you would agree that someone taking a 50% common stock allocation but holding other assets like real assets, absolute return, IBonds and so on would benefit far more from lack of correlation which would further improve results? I understand your reasons for a simple ScV and commercial paper model and I know you said you are now capable of mixing in US LcV etc, but I assume this is one of the benefits of being highly diversified that your real withdrawable return can actually increase (even though the returns of ScV Index don't necessarily increase) because of the smaller fluctuations and greater diversity of holdings allow one to more frequently avoid selling assets for less that their inflation-adjusted starting valuation when FIREing? Thus side stepping as much as possible the situation where US total market has a historical 7% real return but only delivers a 4% withdrawal rate when combined in a 60/40 US bond split scenario.

Currently I am exploring some New Zealand timberland which is managed in a partnership of 200 investors, grown over a 20 year cycle before harvesting, has a historical return of 7.1% real (before taxes) and -0.37 correlation to the S&P 500. Seems to be one of the few ways to get into some endowment-like private real assets with the same benefits of zero correlation to equity markets. :lol:

Petey

JWR1945 wrote:Have fun.

John R.

JWR1945
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Post by JWR1945 » Thu Feb 03, 2005 12:33 pm

peteyperson wrote:Currently I am exploring some New Zealand timberland which is managed in a partnership of 200 investors, grown over a 20 year cycle before harvesting, has a historical return of 7.1% real (before taxes) and -0.37 correlation to the S&P 500. Seems to be one of the few ways to get into some endowment-like private real assets with the same benefits of zero correlation to equity markets.

Always allow for the possibility of fraud. Limit your commitment to the extent that fraud seems plausible. Just remember that lots of experts including accountants have endorsed things such as Enron. All of us can be hurt by fraud. I know of no way to eliminate this risk.

I needed to say those words because your investment looks fantastic. The return is excellent. It is doable. Not only that, you are avoiding the most serious flaw in slicing and dicing.

[If you include lousy investment classes, you limit your volatility by limiting the upside. The overall return with rebalancing is slightly better than the weighted average of the investments (assuming that you pay attention to correlations). If the weighted average is brought down low enough by a lousy investment class, you can end up hurting yourself.]

A seven percent real return in today's world is one worth an over-sized allocation. I cannot advise you on currency risk and political risk in New Zealand. You have to assess those on your own.

Still, look at this very carefully and be prepared to commit funds as heavily as you can comfortably afford.

Have fun.

John R.

JWR1945
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Post by JWR1945 » Thu Feb 03, 2005 1:02 pm

peteyperson wrote:Just thinking about this, I would assume you would agree that someone taking a 50% common stock allocation but holding other assets like real assets, absolute return, IBonds and so on would benefit far more from lack of correlation which would further improve results?

Real assets can be excellent investments, especially if you have the personality to manage them on your own (as opposed to buying REITs). [Be careful about the local financial and political environment.]

With commercial real estate, especially with office buildings, we in the United States routinely oscillate between feast and famine. No lack of supply ever stops when it is filled. Building continues until vacancies abound.

Ibonds (in the United States and their equivalents elsewhere) have the wonderful feature that they can be converted to cash almost immediately. (With US Ibonds, you have to wait twelve months. After that you can cash them out at any time.) You may not be able to time things successfully in one or two years, but you may be able to spot an outstanding opportunity at least once in a decade.

High dividend stocks are attractive during distribution since they can reduce your need to sell shares when prices are low. David Dreman's research (as well as that by others) shows that higher dividend stocks outperform the market as a whole. [His best selection advice favors choosing from companies with the highest 40% of dividend yields instead of restricting yourself to the very highest 20%.]

Avoid the trap of accepting inferior investment classes simply to reduce correlations.

Commercial paper is an inferior investment class.

Take your own abilities and desires into account. Sometimes, you can help yourself by looking deeply into things such as the New Zealand timberland venture. At other times, you are far better investing in index funds because the rewards from individual stock purchases do not make up for the drain on your time.

Have fun.

John R.

peteyperson
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Post by peteyperson » Fri Feb 04, 2005 1:31 pm

Oh very much so. I have a 5% allocation to managed timber, 2.5% of which is planned for Canada's TimberWest listed stock and the other for NZ. This is instead of Plum Creek which is out because of likely further US dollar declines as the US Gov't continues to borrow, which reduces my real return to nothing on timber.

I was initially quite skeptical, however I made timberland my first asset class I researched deeply and so I am pretty knowledgeable now. This first is the largest and has been around for 30 years. One can visit the forest if one chooses and it seems all above board. I will be investigating over time as it is not a committment I am likely to make for a few years anyway. The returns are in line with what is achievable in the asset class, what GMO, Prudential Timber and TimberWest achieve. It is not a case where promised returns are extreme.

The plan is to hold concentrated investments within each asset class, but to hold multiple asset class, so the risk is minimal per investment. For instance, I plan to own 15% in UK commercial real estate and whilst I may only own 5 real estate companies, they will possess the highest quality assets & management and the largest position is likely to be 4%. So even if one company did suffer a meltdown, property sold at auction for half replacement value and leverage is paid off with the proceeds leaving nothing for investors, I'm still only on the line for 4%. This is one years worth of real return for the portfolio, so the risks are minimal but the benefits of concentrated positions should more than compensate for the risk involved which I consider to be small anyway. I also consider what is truly asset-backed and what is not. I am considering a self-storage property company, but I appreciate that whilst it is in theory asset backed, the resale value of retail-located, custom-built, storage facilities with no other easy alternative uses without extensive rebuilding is of questionable resale value at auction when looking at the book value on their balance sheet. This I would therefore consider a more speculative, risky investment and treat it accordingly. Perhaps reducing the allocation but still taking a position if I felt the likely return compensated for the risk accepted in the investment. So I might place 1% there of the 15% allocation with an expected real return of 6%. This represents a reasonable outcome distribution.

Petey

JWR1945 wrote:
peteyperson wrote:Currently I am exploring some New Zealand timberland which is managed in a partnership of 200 investors, grown over a 20 year cycle before harvesting, has a historical return of 7.1% real (before taxes) and -0.37 correlation to the S&P 500. Seems to be one of the few ways to get into some endowment-like private real assets with the same benefits of zero correlation to equity markets.

Always allow for the possibility of fraud. Limit your commitment to the extent that fraud seems plausible. Just remember that lots of experts including accountants have endorsed things such as Enron. All of us can be hurt by fraud. I know of no way to eliminate this risk.

I needed to say those words because your investment looks fantastic. The return is excellent. It is doable. Not only that, you are avoiding the most serious flaw in slicing and dicing.

[If you include lousy investment classes, you limit your volatility by limiting the upside. The overall return with rebalancing is slightly better than the weighted average of the investments (assuming that you pay attention to correlations). If the weighted average is brought down low enough by a lousy investment class, you can end up hurting yourself.]

A seven percent real return in today's world is one worth an over-sized allocation. I cannot advise you on currency risk and political risk in New Zealand. You have to assess those on your own.

Still, look at this very carefully and be prepared to commit funds as heavily as you can comfortably afford.

Have fun.

John R.

peteyperson
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Posts: 525
Joined: Tue Nov 26, 2002 6:46 am

Post by peteyperson » Fri Feb 04, 2005 1:36 pm

I agree. I have a post I wrote in my head while I was out today which encapsulates my latest thinking on asset class selection and your thoughts on withdrawal rate and valuation strategies. Your post touches on this, but I will expand on that. I hope it will be provide food for thought, much nodding of heads and meaningful discussion. I am just trying to be able to say it in fewer words so the message is clear. Trying to take sometimes complex stuff based on simple ideas and boil it down into a post is often difficult. :lol:

Petey

JWR1945 wrote:
peteyperson wrote:Just thinking about this, I would assume you would agree that someone taking a 50% common stock allocation but holding other assets like real assets, absolute return, IBonds and so on would benefit far more from lack of correlation which would further improve results?

Real assets can be excellent investments, especially if you have the personality to manage them on your own (as opposed to buying REITs). [Be careful about the local financial and political environment.]

With commercial real estate, especially with office buildings, we in the United States routinely oscillate between feast and famine. No lack of supply ever stops when it is filled. Building continues until vacancies abound.

Ibonds (in the United States and their equivalents elsewhere) have the wonderful feature that they can be converted to cash almost immediately. (With US Ibonds, you have to wait twelve months. After that you can cash them out at any time.) You may not be able to time things successfully in one or two years, but you may be able to spot an outstanding opportunity at least once in a decade.

High dividend stocks are attractive during distribution since they can reduce your need to sell shares when prices are low. David Dreman's research (as well as that by others) shows that higher dividend stocks outperform the market as a whole. [His best selection advice favors choosing from companies with the highest 40% of dividend yields instead of restricting yourself to the very highest 20%.]

Avoid the trap of accepting inferior investment classes simply to reduce correlations.

Commercial paper is an inferior investment class.

Take your own abilities and desires into account. Sometimes, you can help yourself by looking deeply into things such as the New Zealand timberland venture. At other times, you are far better investing in index funds because the rewards from individual stock purchases do not make up for the drain on your time.

Have fun.

John R.

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

Post by JWR1945 » Fri Feb 04, 2005 2:21 pm

peteyperson wrote:Trying to take sometimes complex stuff based on simple ideas and boil it down into a post is often difficult.

A simple presentation of ideas is much different from a presentation of simple ideas.

Many people misinterpret ideas that are presented clearly. Because they can understand the material, they conclude that it did not require much effort.

The opposite is true. Clearly presented ideas require clarity of thought. Clarity of thought demands a complete mastery of the subject matter.

Have fun.

John R.

peteyperson
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Joined: Tue Nov 26, 2002 6:46 am

Post by peteyperson » Sat Feb 05, 2005 4:56 am

Well said.

Petey

JWR1945 wrote:Trying to take sometimes complex stuff based on simple ideas and boil it down into a post is often difficult.

A simple presentation of ideas is much different from a presentation of simple ideas.

Many people misinterpret ideas that are presented clearly. Because they can understand the material, they conclude that it did not require much effort.

The opposite is true. Clearly presented ideas require clarity of thought. Clarity of thought demands a complete mastery of the subject matter.

Have fun.

John R.

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