Switching: Help a New Member

Research on Safe Withdrawal Rates

Moderator: hocus2004

Lena
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Switching: Help a New Member

Post by Lena »

I have been visiting this board for awhile and reading all the research posts with great interest. I think I understand what you're saying, but I need someone to explain it in words of less than three syllables, leaving out the references to whose study says what (I'll trust you on that), and assume that I don't know anything about mathematical formulas.

I realize that most of you on this board are much more sophisticated investors than I, but I'm asking for your indulgence. Usually, the only part of your research that I can fully understand is the conclusion.

So, switching allocations....anyone?
hocus2004
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Post by hocus2004 »

Usually, the only part of your research that I can fully understand is the conclusion.

That's me! I usually just skip all the numbers junk and drop right down to the juicy conclusion statements. And I'm the founder of the board! So not to worry, Lena, you fit in just fine. Welcome to the community.

I'll try to explain what is meant by "switching." Promise me that, if there is a part of what I say that you do not understand, you will come back with a question. It is not just you who is struggling with this stuff. Lots of others are too, and those are the people we are trying to reach with this message. So please help me out by letting me know where my explanation loses you.

To "switch" means to change your stock allocation. Say that investor A has a 74 percent S&P (that's the Standard and Poor's stock index) allocation and that Investor B has a 30 percent S&P allocation but with an intent to increase his S&P allocation as the level of overvaluation in the S&P index declines. JWR1945 is reporting that the historical data says that Investor B can afford to take more out his portfolio, presuming that stocks perform in the future as they have in the past.

Another word for switching is "timing." We started using "Switching" because timing has become a dirty word in some circles. It is all the result of an unfortunate misunderstanding as to what the research says about whether timing is possible or not.

To "time" the market means to invest more in stocks at times when you think you will do well and less at times when you think you will not do well. A lot of publicity has been devoted in recent years to studies that show that "timing doesn't work."

Those studies are valid in one sense and not in another. It is probably true that short-term timing generally does not work. Short-term timing would be, if you thought that stocks were going to go up over the next two years, you would increase your stock allocation. The data shows that it is very hard to succeed at this sort of timing, short-term timing.

Long-term timing is what we are advocating at this board. Long-term timing is something very different.

With long-term timing, you are not saying that you expect stocks to do well or poorly in the next year or two or three. You are saying that it makes sense to increase your stock allocation when prices are low and lower your stock allocation when prices are high. It is the old "buy low, sell high" philosophy. That's really all that we are advoating at this board. It is a very simple concept, a very common-sense concept.

Say that JWR1945 were to report that the SWR for a 74 percent S&P stock allocation is 1.6 percent. That's an extremely low number, the lowest ever seen in history. That's the number that applied in January 2000, the top of the recent bubble. JWR1945 is telling you that stocks are a bad bet at those sorts of price levels.

Say that stocks went up by 30 percent in the following 12 months. Would that mean that JWR1945 messed up? It would not! JWR1945 is not making any claims at all as to how stocks will perform in the short term. He is making claims only as to how they are likely to perform over the course of the next 20 or 30 years.

JWR1945 is saying that switching allows you to take more out of your portfolio with reasonable safety that your portfolio will survive 30 years of retirement. Lots of investors today disdain switching. They say that you should always have just about everything in stocks, no exceptions. We are disputing that. We are saying that the historical data shows that investors who "switch" or "time" have in the past done better than those who have not.

We can't offer guarantees as to what will happen in the future, of course. All that we are doing is reporting on what happened in the past. It is really a common sense idea to "time" or to "switch." It is always a good idea to buy things at a lower price rather than at a higher price. So why shouldn't the same be true with stocks?

The controversy is all because of this unfortunate misperception that there is some sort of "proof" out there that timing does not work. There is indeed some proof that short-term timing is very hard to pull off. Stocks are just too unpredictable in the short term for this sort o thing to work for the average investor. It does not appear to be too hard for the average investor to profit from long-term timing, however. The historical data indicates that this is very possible indeed, and probably something that most aspiring early retirees should at least be looking into.

Chapter Two of William Bernstein's book "The Four Pillars of Investing" explains all of this in some depth. I recommend that those trying to get a grasp of this read that chapter with care. I go back to it every few months and read it again, and I usually learn somethng new from doing so. I think that just reading that chapter could allow a lot of people to retire years earlier than they otherwise could. It is very important and very powerful stuff.

Please let me know how I did, Lena. Please let me know what was clear and what was not. The point is not for me and JWR1945 to talk to each other. We need to communicate with people like you, people who are hoping to put these ideas to some practical use. You can help us a lot by providing us some straight-talking feedback on what parts of the message are getting across and what parts are not.
JWR1945
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Post by JWR1945 »

I wrote this while hocus was posting his response. I think that his reply was excellent.

Welcome, Lena and thank you for asking your question.
Lena wrote:I have been visiting this board for awhile and reading all the research posts with great interest. I think I understand what you're saying, but I need someone to explain it in words of less than three syllables...
...
So, switching allocations....anyone?
When I use the word allocation, I am referring to the percentage of a portfolio that is in stocks (as opposed to bonds or something else).

Switching allocations means taking money out of stocks when stock prices are high and buying stocks when stock prices are low.

In the old days, this was called common sense.

Our investigations put some numbers along side of our common sense conclusions.

The following numbers are in real dollars. That is, they are adjusted to match inflation. Withdrawals of 4% mean 4% plus inflation. If inflation is 3%, the withdrawal amount totals 7%.

If we look at fixed stock allocations and find out how well they would have done in the past, we would end up limiting our withdrawals to 4% if we demand a high level of safety. If we take money off the table when stock prices are high and look at the same conditions, this withdrawal rate increases to 5% or more.

Price fluctuations explain why the original number was 4% instead of the long-term return of the stock market of 6% or 7%. If you withdraw the same amount each year, you are likely to end up selling too many shares when prices are low. [This is dollar cost averaging working in reverse.]

Too many people think that it is impossible to know when prices are high or low. Those arguments do not hold water except in the short-term (of one or two years). Yale Professor Robert Shiller showed that P/E10 can be used for predicting stock prices in the medium term (of ten years or so).

Welcome and have fun.

John R.
peteyperson
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Post by peteyperson »

Lena wrote:I have been visiting this board for awhile and reading all the research posts with great interest. I think I understand what you're saying, but I need someone to explain it in words of less than three syllables, leaving out the references to whose study says what (I'll trust you on that), and assume that I don't know anything about mathematical formulas.

I realize that most of you on this board are much more sophisticated investors than I, but I'm asking for your indulgence. Usually, the only part of your research that I can fully understand is the conclusion.

So, switching allocations....anyone?
Hi Lena,

I have attempted below to give you a tutorial which explains some basic concepts about how you can value the stock market and know when it is over or underpriced. This explains why my reply to your looks quite long! :lol:

The returns of the large stocks in the US are made up of three components:

1. Growth in the earnings of the business(es).
2. Initial cash dividend yield.
3. Adjustment to valuations after purchase.

Investors pay a multiple of last year's earnings when they buy a stock (or an index for that matter). The long-term average is approximately $14 for every dollar a business earned the year before. So if the business made a buck a share, the business is worth $14 a share. The price to earnings ratio (P/E) would be 14. Now, market prices in the short-term reflect investor psychology pushing prices sometimes up way above what the businesses are really worth and at other times down to really cheap prices because everyone goes off common stocks. They instead move into oil or gold or real estate.

The S&P component returns are as follows:

Earnings growth 4.2% + Initial Dividend Yield 4.5% + Valuation Adjustment 1.6% = 10.3%

The valuation adjustment is from investors gradually over many years bidding up the average price one is paying for that single dollar of earnings. Whilst investors typically think that the stock market moves with economic improvements, there have been plenty of occasions where the US economy was doing wonderfully but the stock market was falling. Here investors had lost confidence in common stocks and didn't care about the good economic news.

To give some perspective to this. If PE 14 is average, as is a dividend yield of 4.5%, earnings growth of 4.2% and a modest improvement in the P/E ratio overtime, then one can use these are a rough barometer on valuations. In 1966 the market peaked and then fell continuously. By 1982 the market was back up to the price it was in 1966 (16 years earlier - ignoring inflation). In 1982, stocks had an average PE of 7. Dividend yields were 6.2% for the S&P 500. Investors like Warren Buffett sensed a bargain and could not buy quality companies fast enough (he said at the time that he had more ideas than cash). Something that usually costs $14 was going for $7! I can buy in and receive a 6.2% cash dividend which I could live off safely or I can use to buy even more shares again at a realy cheap price.

The "value premium" that Buffett is known for revolves around his buying companies at PE 7 and waiting for other investors to start to see the market rise again, gain more confidence and start to buy stocks once more. This gradually adjusts up the multiple of earnings those investors are willing to pay for that single dollar of earnings last year. Gradually that gets pushed up from the low 7s to 14s. For Buffett not only do his companies grow earnings, some pay dividends too, but almost all benefitted from a doubling of the way they were valued. This is all because he has the clear understanding that US businesses are fundamentally sound regardless of what everyone else thinks. He knows investors go thru euphoria & depression and it is best to be greedy when everyone is unhappy.

The flipside of this is where we are now with the S&P 500. In 1999 it peaked. Market prices had ridden up so far that dividends were down to just 1.2% for anyone who bought stock in 1999. Remember, returns are comprised of earnings growth + dividend yield + valuation change (P/E ratio change). Today even if one were to achieve the historical 4.2% in earnings growth, you won't be getting the average cash dividend of 4.5%. You are instead only going to receive around 1.7% dividend. This is a shortfall of 2.6% you won't be getting each year and this reduces your future expected returns in the same way that in 1982 with the dividend of 6.2%, you were getting more than the average 4.5% cash dividend, and as long as earnings grew respectably, you were getting a good deal back then. Lastly, as with Warren Buffett benefiting from a subsequent uplift in valuations because he got such a cheap deal, if one overpays for a business (or an index), markets will eventually even out and the multiple of earnings will fall (P/E ratio will fall). This reduces the value of your investment and so reduces the return you will receive. i.e. If it is normal to pay $14 for a company that made $1 last year, but instead you pay $20 for the company, that value will fall over time. This will hurt your returns. Also as you paid more for your stock your dividend yield is lower. The company still pays the same amount of cash out but as you paid more, it is a smaller percentage of the steep price you paid.

The S&P 500 PE moves between 19 and 21 at the moment approx. This is considerably above the average of 14. So anyone still owning the index or making a new purchase will likely experience some damage to their valuations over the next few years. Earnings growth reflected in thes stock price will slow as the overvaluation is worked out of the price over time. Thus today returns look something like earnings growth (if same as historical) 4.2% + 1.7% dividend - 3% valuation reduction back to PE 14 = 2.9% nominal return. If we say index fees are 0.1%, then 2.8% nominal return. Last I heard US inflation was at least 3%. So we take that off and what are we left with? What was your real (after inflation) return? -0.2%.

This above example ignores any taxes due on dividends received, so the news is worse. It is also not guaranteed that earnings growth will be 4.2%. The US economy is sluggish and everyone is indebted so consumer spending is less likely to pick up the slack. It wouldn't therefore be unreasonable to expect a little less growth that one has enjoyed in the past until consumers have paid down their debts. So far few are doing so.

As you can see, the future expected 10 year return for the S&P 500 isn't looking tasty. Historical real returns for US stocks are 6.7%. You're not likely to get any of that. Why not? Two reasons. The dividends aren't 4.5% and still holding stock (or buying today) at PE 19+, you are overpaying for each dollar of future earnings your companies will earn. Simple. This is why Warren Buffett is sitting on cash & bonds worth over $50 Bn. waiting for cheaper prices. He liked buying when he could get that dollar of earnings for $7, but not when he has to pay $20! Almost 3x as much for the same share of the same company (or group of companies in an index fund).

Now I've covered a lot of ground there, May take several read thrus to get it all depending on your level of knowledge. Please don't hestitate to ask any questions you might have. This particular piece is critical for you to understand because once you do, you know when the market is cheap or pricey. That knowledge is useful.

The "switching" referred to on this board is simply that at a time like now where future real returns look highly questionable, some investors feel it is better to sell those investments and place the funds elsewhere either into cheaper assets with better future expected real returns or into cash waiting for cheaper valuations. Often there is an opportunity cost in taking this action. One might be expecting 2% net real return but sell out to wait for something higher. The length of time you end up waiting brings into question whether you'll outrun how much you would have made sitting pat earning your 2%. However as I've outlined above, the real expected return is zero. Almost all individual investors, I would estimate in excess of 99.5%, have no clue about any of this stuff. People in their 50s retired in 2000 with the P/E ratio around 30, dividend yields then 1.4% and then went bleeting to the newspaper reporters when they were "forced" en masse back to work because their stock halved in value. Even a cursory study of market fundamentals would have made it obvious that prices were double what they should have been and it wasn't going to end well. The Emperor has no clothes! In their shoes I would either have sold out and move money into other asset classes that were cheaper or I would have lowered my expected future returns to reflect the likelihood that the stocks would half in value back to PE 14..

As I say, if none of that is clear, please speak up. Once you have this clear in your head it is tremendously useful but takes a bit of doing the first time.

Petey
Delawaredave
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Post by Delawaredave »

I thought the average historical PE was closer to 16 ?

Also I read somewhere (Jeremy Siegel ?) that an average PE these days should be expected to be a little higher than PE's 20-40 years ago -- because there's more liquidity, more public information, and tighter accounting -- so one should pay a slightly higher multiple today.

Question is how much higher ? I think our current PE of 20 is high by anyone's standards...

Hey - while we're talking about "definitions" what is "accumulation stage" ?

I though that was accumulating savings while you worked. But I've seen several posts by people that seem already retired who talk that they are in "accumulation stage" ?

Thanks............
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Post by MacDuff »

JWR1945 wrote:The following numbers are in real dollars. That is, they are adjusted to match inflation. Withdrawals of 4% mean 4% plus inflation. If inflation is 3%, the withdrawal amount totals 7%.
Hmm. I must not understand the way you are using these rates. With my math, if one is using a 4% withdrawal rate, and that first year experiences 3% inflation, his withdrawal rate in the next year, to maintain real consumption would 4.12% rather than 7% of the original portfolio.

For example using a $1,000,000 portfolio, and a 4% real withdrawal rate, one would take $40,000 the first year,Y0. Then in year Y1, he would need $40,000 +(3%*40,000), or $40,000 +$1200 = $41,200. Dividing this amount by our index portfolio value of $1,000,000 gives a second year withdrawal rate of 4.12%.

Am I confused here?
mac
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Post by MacDuff »

peteyperson wrote:As I say, if none of that is clear, please speak up. Once you have this clear in your head it is tremendously useful but takes a bit of doing the first time.Petey
Very interesting exposition. But I imagine Lena'a problem is more down to earth, as is mine. Say one is absolutely convinced that varying his/her allocation to stocks according to PE10 is a great idea.(I am so convinced.)

Given that , what is the algorithm for making the switches? It shouldn't take more than 4 sentences to give it. I keep coming back to this board attracted by the obviously intelligent and helpful people who post here. But then I always go away, convinced that no one is going to part with the magic formuila. Maybe it could be succinctly stated and placed in a sticky folder, so anyone could get quickly up to speed about what is being debated here.

PS I just read a lot more stuff, and I see that perhaps as yet you don't have a protocol-"If this, allocate that". I just read through a long piece on "A Sanity Check". If I understand that correctly, you choose a lower boundry below which you allocate 100% stocks, and an upper boundry above which you own no stocks. Between these you use one "intermediate allocation", which in your examples has been 30,50, or 70%. If I understand correctly, you haven't used finer divisions within the intermediate category. Is this correct?

Mac
peteyperson
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Post by peteyperson »

Hi Dave,

Well opinion varies on average PE. Jeremy Grantham says it is likely to be more like 16 because the world is a safer place now. This was before 911 and a resurgence of terrorism on home soil. I tend to work with the Bogle data of 14.1x and use 16x for higher quality businesses that have unique products and high returns on equity. Your Coke, Pepsi, Microsoft, Harley Davidson and so on. Better businesses with wider net margins & higher returns on equity survive through recessions in better shape and so are worth more than the average business. This is a 14% upgrade from the 14.1x used in Bogle's Common Sense on Mutual Funds. I think that is an okay premium to use, and my own personal assessment and logic.

PE 20 is high but there are some businesses available with the characteristic above available for PE 16 still. Even in the large/mid-cap arena. One just has to look. The typical mutual fund holds 40+ stocks and so they typically will say stocks are too expensive or the stock float is too small for funds with an excess of investable funds to deploy. But the smaller investor has neither problem. So markets being too high is relative to your situation. They are certainly not cheap but using my metrics above, there are enough businesses sitting at historically average valuations today contrary to what the popular press print. Certainly that doesn't include the likes of Pepsi or Coke but then one wouldn't expect that for two reasons. Firstly, everyone knows about their businesses & so the price almost never falls enough. Secondly, better results can be found in lesser known successful businesses that trade at cheap valuations until their successive business results bring them to the attention of more investors, when they then become valued like Coke!

I term saving as ' The accumulation phase ' and ' The distribution phase '. Your planned/actual asset allocation may well be different for each and so I have two columns in my spreadsheet to allow for different allocations to a selection of asset classes. Some assets are only used in one phase and not another.

What do you say to all that? :lol:

Petey
Delawaredave wrote:I thought the average historical PE was closer to 16 ?

Also I read somewhere (Jeremy Siegel ?) that an average PE these days should be expected to be a little higher than PE's 20-40 years ago -- because there's more liquidity, more public information, and tighter accounting -- so one should pay a slightly higher multiple today.

Question is how much higher ? I think our current PE of 20 is high by anyone's standards...

Hey - while we're talking about "definitions" what is "accumulation stage" ?

I though that was accumulating savings while you worked. But I've seen several posts by people that seem already retired who talk that they are in "accumulation stage" ?

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

Post by peteyperson »

MacDuff wrote:
JWR1945 wrote:The following numbers are in real dollars. That is, they are adjusted to match inflation. Withdrawals of 4% mean 4% plus inflation. If inflation is 3%, the withdrawal amount totals 7%.
Hmm. I must not understand the way you are using these rates. With my math, if one is using a 4% withdrawal rate, and that first year experiences 3% inflation, his withdrawal rate in the next year, to maintain real consumption would 4.12% rather than 7% of the original portfolio.

For example using a $1,000,000 portfolio, and a 4% real withdrawal rate, one would take $40,000 the first year,Y0. Then in year Y1, he would need $40,000 +(3%*40,000), or $40,000 +$1200 = $41,200. Dividing this amount by our index portfolio value of $1,000,000 gives a second year withdrawal rate of 4.12%.

Am I confused here?
mac
Hi MacDuff (& Lena),

You're not confused so much as you missed a rung on the ladder!

This is a long reply. However, I have broken in into bite-size chunks with the use of a line breaking =-= . These form natural stop points for you to go away to consider what has been explained thus far. Otherwise it may be too much to take in at once, but I think you'll find it very rewarding indeed. It took me a good couple of hours to do this for you, just so you know.

=-=

Lets imagine that one has $1,000,000 and you plan to use the funds ongoing, not spending down the money. Your investments deliver 7.5%, your fees were 0.50%, you have 7% available to withdraw.

In year #1, your investment grows to $1,070,000 net of fees.

Now over the course of the year #1, inflation was 3%. In order to keep your original nest egg ($1m) up with inflation - maintaining your buying power from year to year - you need to keep enough of your investment return to achieve this. This is to ensure that in a decade you won't still have $1m when everything in the stores is 50% more expensive by then..

Therefore, whilst you now have $1,070,000, your original inflation-adjusted nest egg is now worth $1,030,000. That sum at the start of year #2 is worth the same as $1m was at the start of year #1. It sounds like it is more money, but it buys the same as it did before cos everything got more expensive over the year..

What is left above this level is what you can withdraw. In this case, you have $1,070,000 (net of fees), you keep $1,030,000 and withdraw $40,000 (4%).

During year #2, your new nest egg of $1,030,000 will grow at 7% (net of fees) to $1,102,100. The nest egg needs to kept up with inflation, so we add 3% to $1,030,000 to work that out = $1,060,900. What do we have available to withdraw? $1,102,100 less $1,060,900 = $41,200.

Note that you'll find that $41,200 is exactly 3% more than your first year withdrawal of $40,000.


=-=

Hopefully that is clear. Please re-read if it isn't and let me know if I can help further.. It is very fundamental to getting how investment returns and living off them work.

=-=

The next step is a leap in thinking. One should only read this when one is clear about the foregoing, otherwise it will only confuse. Really..

-Portfolio construction-

Investments are volatile year-to-year. Being able to just withdraw 4% a year is difficult. Some years you get -10%, some years +5%. One therefore constructs a portfolio, a collection of different types of assets (called asset classes) which perform differently and mixed together give a more reliable return year-to-year. The fun comes in trying to find assets that work differently together, exhibiting what is called a lack of correlation. They move in different directions to different stimuli. If interest rates & inflation move up, for instance, one may fall, the other may rise. That sort of thing. So people debate the merits of various investments and how they mix together.

=-=

-Market Returns vs Withdrawal Rates-

From 1900-2000, the US stock market delivered 10.1% nominal return, 6.7% real return. Inflation was 3.4%. This is for the Wilshire 5000 Index - the total market.

From 1900-2000, the US bond market delivered 4.8% nominal return, 1.6% real return. Inflation was 3.4%. This is for the Total Bond Market Index.

A 70/30 mix of these two assets would have delivered 5.17% 'real' (after inflation) return.

Does this mean we can actually withdraw 5.17% a year? Only in a perfect world. Returns will still be lumpy each year. Some years stocks will fall 50% and yet you still need to live in retirement. So you will sell stocks to live. Only because your stock fell in price, you'll have to sell more shares than before to achieve this goal. If one ignores inflation, each year from your $1,000,000 nest egg, you want $40,000. If this balance were to fall to $500,000 you would still have a need for $40,000. So you would sell enough shares to do so. The problem here is that it came at a big cost. You sold shares that were worth half what they were the year before. This eats thru your money faster. You in fact sold 8% of the $500,000 remaining in order to live. Do that for a few years in a row and you'll have some problems! The stock market may rebound 10 years later, but you'll no longer own most of the shares you started with, helping you not at all. The way investors handle this problem is to diversify.

Firstly, some stocks do provide cash dividend payments to you each year. These whilst often taxable each year as you accumulate money, do provide some of the money you need to live later. This provides a stream of income - a cushion - and reduces the assets you have to sell. If your dividends were 2% and you plan to withdraw 4%, you only need to sell 2% in stocks each year. In the above example when your stocks portfolio has fallen in value by 50%, this would mean selling 4% of the nest egg to get that portion of your living expenses. Not great when selling at half price, but doing a lot less damage to the long lasting value of your portfolio during bad times. It is worth noting here that just become the market can fall 50%, cash dividend payments made by companies do not necessarily fall too. If the businesses are still just as profitable and the market declining is a 'market event' and not because the US economy is tanking, then profits/earnings are still the same and the cash dividend just keeps on being paid to you.

The other impact I'm sure you'll be thinking about is what about inflation? Your nest egg needs to rebound to its previous level, plus inflation over the period too. Your withdraws as you rightly said will need to increase with inflation. This increases the impact of withdrawals when your nest egg has fallen. All the more reason that investors put a lot into asset class selection to try to avoid your whole portfolio falling 40%. Inflation has typically hammered people just when the market tanked. This happened in the 70s and 80s. Between 1973-4 the US market fell 37%. Inflation was in double-digits those years. By comparison, between 1929-32 the US market fell 60%, however it was a deflationary environment where the consumer's budget was falling. So it is a wash as to which was worse when adjusting for inflation.

=--=

-Withdrawal Rates Redux-

Putting this together, what it means is that whilst a 70/30 stock/bond mix would have offered 5.17% real returns to you, this is only true if you never sold when the market was down. When you are retired this basically means using the $1,000,000 nest egg and adjusting it for inflation as you go along. If you sell down when your portfolio is below that figure, you're taking a hit. Within the portfolio you'll have a mix of assets. At different times some will be cheap and some will be overvalued. Most people rebalance - selling the overpriced assets and buying some underpriced assets - in order to keep things in order. Stocks grow faster than bonds, so this process helps to not have stocks become 90% of your portfolio when you weren't looking, then they tank 50% and you're in a bind. The more bonds one owns, the less volatile your portfolio will be. Stocks are the more volatile and deliver the best returns.

In more recent years, investors have begun to see the merits in "slicing and dicing" the market far more. French & Fama, two economics professors, discovered that buying stocks that are cheaper than the market can offer a "value premium" because those companies tend to rise back to the same value as the market over time. This adds incrementally to your investment return. They also discovered that smaller stocks (both small and micro capitalisation) offer a higher return to investors. Both can increase the volatility individually, but putting these assets together can reduce the portfolio volatility. This sounds counterintuitive. What happens is whilst both may typically move up and down 20% in any given year, one asset may go up when inflation rises and the other may go down when inflation rises. Both starting at 100, asset #1 would rise to 120, asset #2 would fall to 80. Diversification worked well in this example and could choose to sell some asset #1 to fund living expenses or indeed a mix of both. The point is both assets didn't fall together to 80 leaving you stuck and burning through your nest egg way too quickly.

Whether one would get the theoretical 5.17% real return would depend on how well one's portfolio was constructed. This mix is just US stocks and US bonds. Contrary to popular belief, the US stock market was not the highest returning stock market over the past century. That honor falls to natural resources-heavy Australia. US stocks and bonds can often respond to the same stimuli. Interest rates & inflation typically move both up or down at the same time, for instance. Treasury bonds are a good bet as a foundation to your portfolio, delivering minimal real returns for this 'insurance' but are poor investments a lot of the time for diversification purposes. Bonds of the same country tend to move with their stock cousins much of the time. Broader diversfication therefore is the key. The more one can smooth out the yearly return and reduce the likely impact of withdrawals just when your investments have falled sharply, the higher withdrawal rate you will enjoy. Sometimes this means owning lower returning investments like bonds in order to create that smoother path.

=-=

Dimensional Fund Investors are the best indexers in the business today. They have special techniques that get into the smaller stocks much more effectively and their returns are higher. They opt for a heavily diversified approach to asset class mix. For instance, they own US large co stocks, US large co. value stocks (the cheaper ones that give a "value premium" long-term), US small co. stock, US small value stocks, US micro cap stocks. They also diversify abroad with Int'l Large co. stocks, Int'l value stocks, Int'l small co. stocks and so on. Emerging market stocks are also split. They also have a low (too low IMHO) allocation to real estate.

Real estate is particularly useful because REITs are liquid, provide dividends in a range between 4-7% depending on the real estate cycle and capital price gains in line with inflation (replacement costs of well-placed, well-maintained buildings rises with the cost of building a similar building with increased brick, lumber, labor & land costs - natural inflation hedge ex overbuilding in the region). This boost to dividend income allows one to sell fewer shares in bad market periods because your annual income stream is commensurably higher. The downside is that returns whilst very healthy are not as good as one can achieve long-term in small cap value and micro cap globally. But as you may be starting to understand, it is not all about shooting for the moon. Some of the best returning asset classes historically may now have a lousy 20 years. Indeed whilst UK Small Cap stocks have a 3.4% premium over their larger cap brethren, there were 19 years thru the 80s and 90s that they underperformed the larger cappers. This is why one diversifies heavily.

Real assets is becoming a key plank in asset allocations today. Managed timber in the form of REIT shares of Plum Creek Timber Co. or Rayonier, and allocations to oil & gas, gold & commodities become typical. As are absolute return strategies which make profits from the market while being mostly isolated from market movements in any six month period. None of these investments match results from common stocks long-term but one doesn't own them for that purpose. Oil & gas, gold & commodities typically are the assets that rise substantially when the economy is not doing well and/or when there is some kind of crisis with common stocks. Returns long-term are nothing to get excited about, but profits for oil companies can jump when the price of oil does, which causes common stock profits to fall because they need the oil commodity to do business. So there is a lack of correlation at times and one saw this very recently as Oil went to $55 and at the time of writing has risen again back to $50, which caused a stream of profit special announcements from companies citing high oil prices as a cause for falling short of their previously announced profit estimates.

Dimensional includes these assets within their general index (with the exception of real estate which has its own index fund) but it is unclear whether this is enough. It would have been very convenient in the 70s to have been able to trim your massive gains from oil investments (Oil quadrupled) in order to use part of it to live and to rebalance by buying stocks which were back then priced at PE 7! One does not need to even understand different valuation metrics to trigger this decision. A friend who posts here, Ben, he has 10% allocated to his asset classes and simply sells every year when one goes over the 10% and tops up the assets that have fallen below 10%. No heavy lifting necessary! By including all real assets bar real estate in their index funds, Dimensional do not provide this option. Whilst all index & active funds will likely contain some oil & gas stocks, it is the ability to separately sell down just those assets that provides the needed flexibility. Often investors make the mistake of thinking they are diversified when they own only US mutual funds because "those companies do a lot of business abroad" but it is not so much the exposure to foreign currencies that is important, it is the reality that stock markets in other countries provide different returns at different times. This provides a miriad of possible assets one can sell in order to release that money needed for living expenses.

Quick page from Dimensional (DFA) on different returns and volatility (standard deviation) for US and Int'l stock markets (easy quick read for you now):
http://www.dfaus.com/strategies/separate/

Example (couple of page lengths down) of how they divide up their Global Portfolio product:
http://www.dfaus.com/strategies/global/

A solid financial advisor has an excellent site (with a downloadable ebook all about what I've detailed above - fun read with drawings etc). Here is his own split for clients using DFA's funds and a 70/30% stock/bond split I've been using for example purposes only:

(See his chart couple of page lengths down with annualised returns on the left side and volatility on the bottom. It is a great graphic interpretation of what one is dealing with and it is easy to 'get it')

http://www.ifa.com/portfolios/p070/index.asp

EBook (Broadband download):
http://ifa.com/bookdownload.asp

Online viable with interactive graphics (amazing effort):
http://www.ifa.com/12steps/Step1/ShortBook.asp


An alternative actively managed and heavily diversified approach is provided by Yale Endowment Fund. David Swensen wrote a terrific book that covered their approach, and the approach of other top-tier Endowment funds like Harvard, Princeton etc. Some of their approach is not possible for private investors, but much of it is, particularly their approach to concentrated portfolios via boutique investment firms that specialise in value and/or small cap stocks globally. Their position as to the merits and lack thereof of holding bonds of varying maturities is also distinctive to top-tier universities and they manage to obtain less volatile returns through diversification with a mix of asset classes but use focused portfolios of small numbers of holdings in order to concentrate of the best opportunities. One of their US large/mid cap value managers, for instnace, hold 8-12 positions for long periods and has outperformed the market by 7%+. Top decile performance (top 10%) is 3% alpha. The firm researches positions heavily and delivers higher returns thru proprietary knowledge. This too is available via select independent US value shops who offer mutual funds. The Yale Endowment portfolio has delivered 17.5% compounded returns net of fees over the past decade.

The annual reports are short and readable, only a few pages in big type, but discuss their approach simply & clearly. The 2000-3 annual reports provide a snapshot as to what results are possible when the S&P 500 tanked 40%+. The 2003 AR report includes a special section (each year there is a special section focus) on their real assets portfolio. This discusses the benefit of investing with managers who focus on a specific property type or location or both. This is perfectly possible for individual investors through the selection of smaller REITs who focus on specific property types and location. Contrarian insights into where money is flowing and where one might deploy capital against that money flow to get a better real return are also illuminating. (Pulling out of venture capital that has been highly successful for them because added money flow into VC is depressing returns making the risk/reward dynamic unprofitable is one such recent example).

http://www.yale.edu/investments/

=--=

Some notes: Taxes on dividends & bond coupons and management fees are excluded from the real return. Typically the withdrawal rate discussed excludes taxes to keep the playing field level but needless to say, owning more bonds which are fully taxable outside of a tax-protection wrapper is not the same thing as an investment that isn't liable to much tax. Thus, bonds not only deliver a much lower real return, but they cost money on taxes every year. The capital gain part of stock returns can be deferred for as long as you still own them. With bonds you only get to compound what money is left after taxes each year, this is a huge drag factor on compounding money up. One can maintain a high stock allocation with low bond allocation (say 80/20) if one diversified heavily and includes a good chunk of real assets. These tend to deliver high dividends that one could live off (or indeed reinvest whilst accumulating assets to live on later) making market price volatility less of an issue that common stocks (operating businesses) that only release a little bit in the form of cash dividends forcing you to gradually sell shares to live. The traditional 60/40 stock/bond split pioneered by the investment industry was back in the day when individual investors could not easily invest in real estate or other real assets, and investing internationally was almost unheard of. Today one can invest easily into international stocks, value stocks, small stops and even into a commodities index fund which in negatively correlated to stocks (no correlation means it has no relationship to stock movements, negative correlation means it actually goes in the opposite direction. +1.00 is perfect correlation to the other asset, 0.00 is no correlation at all, -1.00 is 100% the other direction. 0.50, 0.25, -0.25 & -0.50 are degrees of correlation). Alas, the 60/40 US stock/bond investing mantra as well as thinking that int'l is handled by owning US stocks alone persists to this day.

Some believe in indexing everything, some do not. Some believe that the markets are totally efficient, some do not. Typically, the more smaller size and int'l you go, the less efficient the markets are and the greater ability one has to outperform the market with active funds. Active funds however often suffer from excessive turnover of stocks owned and owning 50+ stocks which makes them track the index rather than outperform it. After fees, they don't compare well. Only those funds that follow a value style and/or hold a concentrated (less than 25 stocks) portfolio typically do so. The top value shops such as Longleaf, Tweedy Browne, Dodge & Cox and so forth provide ample evidence of an ability to provide better than market returns (net of fees) if one chooses to look. Some are so set on "index everything" that they accept the mantra that one cannot beat the markets despite all evidence to the contrary. the DFA site is partly owned by the professors who pioneered findings on the outperformance of the value style & small cap premium, and so they are part of the "index everything" crowd. But they do a superb job! Most people can only get access to Vanguard index funds which whilst very good do not get into the smaller less liquid stocks and so don't perform as well.

=-=

The stuff worked on in the SWR Research Group board is much more on the complicated side of that. It is only liable to confuse newbies to FIRE thinking. I mean that with no disrespect to John, Rob or yourself! One really has to wrap your head around their ideas to understand them and build on what you already have learned. Their work is on the advanced level.

Petey
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Post by hocus2004 »

I though that was accumulating savings while you worked. But I've seen several posts by people that seem already retired who talk that they are in "accumulation stage" ?
Your understanding of what "accumulation stage" means is correct, DelawareDave. It is in application of the concept that things get a little fuzzy.

When JWR1945 says that the SWR for a 74 percent S&P allocation is X percent, the takeout number he is giving you is the number that is 95 percent safe for someone who is living off of that portfolio and nothing else. This way of doing things is something that we just picked up from the conventional methodology SWR studies. For our numbers to be comparable to the numbers generated by the conventional studies, we need to set things up in generally the same way.

The SWR number does not have direct application to someone in the accumulation stage (someone in the process of building up his portfolio rather than withdrawing from it to cover his costs of living). The reason is that the investor in the accumulation stage will not in any circumstances be selling stocks to cover his costs of living; his costs of living are covered by the income he earns. It is selling stocks when prices are down that causes retirements to go bust. The fact that retired investors may be put into circumstances in which they will need to sell stock puts them at a disadvantage. William Bernstein quite properly describes the conventional methodlogy studies as "breakthrough research" because they quantified the cost associated with this disadvantage. It is very important to always keep in mind that the retired investor is at a disadvantage in owning stocks because of the possibility that big price drops may compel him to sell stocks and thereby lose out on the price rises likely to come somewhere down the line.

The fuzziness comes from the fact that many investors are not in a pure accumulation stage or in a pure withdrawal stage. If you are in some sort of mix, you need to adjust for that to understand what sort of realities apply in your circumstances.

JWR1945 is retired, so your initial thought would be to say that he is in the withdrawal stage with his stock investments. That is not really so. JWR1945 has enough money coming in from his pension to cover his costs of living. So there is no circumstance in which he would be required to sell stocks to cover his costs of living. I think that a good argument can be made that the circumstances that apply for JWR1945 are the circumstances that generally apply for an investor in the accumulation stage.

I am sort of "retired" and sort of not. I use withdrawals from my investments to cover some of my costs of living. But I also depend on earning $10,000 per year from my non-corporate work (freelance writing) to cover some of my costs of living. So am I in the accumulation stage or in the withdrawal stage?

I think it depends on how high a stock allocation I go with. If I go with a 100 percent stock allocation, then I cannot afford to take big hits to my portfolio and I would be forced to sell shares with a big price drop. In that case, the withdrawal stage circumstances apply to me.

If I invest 20 percent of my portfolio in stocks, I think that it is more proper to say that the accumulation stage rules apply to me. In that circumstance, I would never need to sell shares because I would have enough coming in from other sources that I would not feel great pressure to sell shares.

You generally can't just take the numbers that we generate and apply them to your own case. Developing an effective investing strategy is a more complicated business than that. This is why I try to stress that the Data-Based SWR Tool is a descriptive tool, not a prescriptive tool. It informs your investing decisions, it does not dictate them.

What our number permit you to do is to make better comparisons between different investment options. Say that it was January 2000 and you were trying to decide between making an investment in the S&P index and an investment in TIPS. The SWR for the S&P index was 1.6 percent at the time and the SWR for TIPS was about 5.8 percent. Those exact numbers probably didn't apply to your particular circumstances, but knowing those two numbers tells you that this is a case where TIPS offer an awfully appealing deal relative to S&P stocks.

The point that I am making in this post is one that I think many people miss. It is missed because most people first learn about SWR analysis from reading conventional methodology studies and the conventional methodology studies report numbers that are so far off the mark from what the historical data actually says that they mess up your thinking as to what SWR analysis is and how it works.

The problem is that the 4 percent number reported in the conventional studies is so high that it tilts the playing field so far in favor of stocks that there are almost no circumstances in which investing in alternate investment classes makes sense. In the past, most people have not used SWR analysis to make comparisons because useful comparisons are not possible when you are using numbers that come from la-la land.

The point of our development of the data-based tool is to change all that. We are using historical data just as with the conventional studies, but we are using it in an analytically valid way. Thus, we get very different numbers. Thus, it becomes possible to use SWR analysis to compare the benefits of alternate asset classes.

The magic of this tool is not in the numbers it generates. The numbers are just the starting point. The exciting part comes with the comparisons between compteting asset classes that you are able to make once you have the numbers in hand.

I hope that all makes some sense. To summarize, I would ask that people be careful not just to pick up numbers from this board and apply them unthinkingly to their own plans. That would be a dangerous thing to do. What you should be doing is using the numbers we generate to ask questions that guide your investment choices. When you see that there are some valuation levels in which the SWR for S&P stocks is 1.6 and other circumstances in which it is 9 percent, that tells you something very important about how you want to set up your stock purchasing strategy. That's the sort of insight that we are trying to point people to, in my view.

Another way of saying it is that the conventional methodology tool was a tactical tool and the data-based tool is a strategic tool. You can use the data-based tool as a tactical tool too. But personally I have less confidence in it when using it that way. I think it does a very good job of pointing investors to sound strategies. When you get to the tactical level, I questiion whether the results are likely to be as good. It can help, but you always need to be careful to make modifications to adjust the findings to make sense in the context of your particular circumstances.
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Post by hocus2004 »

I keep coming back to this board attracted by the obviously intelligent and helpful people who post here. But then I always go away, convinced that no one is going to part with the magic formuila. Maybe it could be succinctly stated and placed in a sticky folder, so anyone could get quickly up to speed about what is being debated here.

Thanks both for the kind words and for the helpful feedback, MacDuff.

You are absolutely right. What we need is a board FAQ. There has been a lot of research at this place and we need to create a single document that sets forth our most important findings in an organized and clear and integrated manner.

I am very much aware of the need for this and have been for some time. Our problem is a manpower problem. JWR1945 is our numbers guy and, as you know, he knocks himself out on that side of things. I don't think it is a good idea for him to take time away from his research to prepare a FAQ statement, which is a big job. I'm the person who should do it, but I am absolutely overwhelmed with the process battles I have to engage in. You have probably noticed that there are a good number of people who want this board shut down and don't want any of this information getting out noway nohow. Someone has to deal with that junk, and I think it is fair to say that I was elected (I voted the other way!).

For the time being, we are a bit stuck. We very much need what you are suggesting. It would be far morre efficient for us to have a FAQ statement that helps bring newcomers up to speed. But you just have to try to understand that this board community has had a gun to its head from the day it was born, and we are just struggling along day to day the best we can.

I am planning to write a Research Report on the realities of SWRs that I will sell at my web site after I publish my book. My aim is to have that report serve as an introducton and summary of the research done at this board. My hope is that that report will do the job that needs to be done. When I am preparing the outline of the report, I will prepare a FAQ statement that will serve those community members who don't care to pay for the report. There are solutions on the drawing board for the problem you are making reference to here.

Now, here's the thing. If you go through the Post Archives of the varous boards, you will see that I first began talking about the Research Report in 2002. That was a long, long time ago. In all the time since, I have been spending most of the hours of my days responding to nonsense gibberish attacks posts by defenders of the conventional methodology (DCMs). This is madness! The DCMs are never going to be able to put up a reasoned case for their position. The SWR is a data-based construct, so it is the data that determines what the number is. The data is never going to change. So all of this deception stuff and intimidation stuff and word game stuff is a huge waste of everyone's time.

We need your help with this aspect of things, MacDuff. There are lots and lots of community members who feel as you do. There are over 100 who have expressed a desire that honest and informed posting on SWRs be permitted at the various Retire Early/FIRE/Passion Saving boards. When you have over 100 community members asking for something, the site administrators should provide it. The site administrators are afraid to "cross" the DCMS. The DCMs do not play around. They are a vicious group. If you want the site administrators to permit honest and informed discussions (and thereby free me up to do work helping community members like you, who are interested in how to retire early instead of this other junk), you need to tell them that you count too. Tell them to enforce the site rules in a reasonable manner.

I think that we can bring ES around. Send him an e-mail telling him that you do not think that there should be any special exceptions from the standard site rules for DCMs. It would be a help if you could send a similar e-mail to raddr, who is the site administrator at raddr-pages.com. We also need e-mails going to Dory36 at the Early Retirement Forum. Most of all, we need them going to TMFBogey at the Motley Fool board. You might want to bypass TMFBogey and just send the e-mail to Tom Gardner, who is the co-founder of the Motley Fool site and who I believe is the person who wrote most of the language in the Motley Fool site rules. I believe that Gardner is going to be sympathetic to our cause.

There are only so many hours of the day that I can spend on the boards. I am knocking myself out to provide you the information you need to make your Retire Early plan work. I very much need a little help. I need e-mails to site administrators. I need to bring this ugliness to an end. We need to get out community back. We are a smart people, a good people, and a creative people. We need to get this community back on the right track.

Don't think that there is nothing that one person can do. Others are watching what goes on with this matter. When one person works up the courage to speak up for permitting honest and informed posting, that counts for 10 because of the amount of intimidation that has been used to quiet those sorts of voices in the past.

I'm going to write the FAQ either way. I am not trying to set up a quid pro qua here. But my view is that anyone who takes from a community when times are good needs to give a little something back when the community is under attack by forces hostile to its core goals. We have been under attack by forces hostile to our core goals for over 34 months now. It is not only our right but our obligation to do a little something for the many community members who come here not for the purposes of personal ego-gratification but to share ideas on how to win financial freedom early in life with others pursuing that same wonderful goal.
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ElSupremo
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Post by ElSupremo »

Greetings hocus :)

Hocus your just not getting it. :?
I think that we can bring ES around. Send him an e-mail telling him that you do not think that there should be any special exceptions from the standard site rules for DCMs.
Since I reinstated you my policy is no exceptions for anyone. Including you. I've explained myself the best I can here:

http://www.nofeeboards.com/boards/viewtopic.php?t=3352

That's the way it is. I think it's a fair proposition for everyone. Act like grown-ups and agree to disagree. Work out your differences in an adult and mature manner. Try to follow the site guidelines the best you can. It's not a perfect world but most of us don't have any problem with this philosophy. 8)
"The best things in life are FREE!"

www.nofeeboards.com
hocus2004
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Post by hocus2004 »

One really has to wrap your head around their ideas to understand them and build on what you already have learned. Their work is on the advanced level.

Some of the stuff posted to this board is complex, to be sure. There is a lot that JWR1945 posts that I cannot read,much less understand.

But our most important findings are actually very simple, common sense, sorts of findings. EVERY aspiring early retiree should be tapping into those insights, in my view.

Our most important finding is that the value proposition associated with the purchase of a share of stock varies according to the price that you pay for it. It doesn't get any more simple than that!

If investing were a rational process, this insight would not be an insight but a truism. It is so obviously so that it seems insulting for me to have to tell people that this is so. But I very much need to tell people. Why? Because 90 percent of the money advisors handing out investment advice today don't see this obvious point. Many of them directly contradict it all the time. So this common-sense insight (I couldn't have come up with it if it required anything more than common sense to do so) very much needs to be stated and defended and explored. It is a powerful, powerful, powerful insight. Tap into this insight, and you reduce the number of years it take you to attain your Retire Early dreams by 3 years or 5 years or 8 years or 11 years. It is a very big deal.

Say that there are two indentical houses located next to each other that go up for sale on the same day. Each is offered for sale for $300,000, which the comps indicate is the fair selling price. Buyer A walks into House 1 and says "Look, I have missed out on five houses that I wanted, so I will offer you $600,000 for this house if you accept the offer within five minutes." The offer is accepted. Buyer B walks into House 2 and says "Look, I have read that the housing market is slowing down and I don't think they you are going to be able to sell this thing to anybody at your stated price, but I will pay you $150,000 in cold cash if you accept it in five minutes." This offer too is accepted.

We now go 10 years down the road. Who is more likely to have earned a profit on his housing investmnet, Buyer A or Buyer B?

Buyer B is in far better shape. That is what we are saying at this board. We are saying that if you buy stocks when they are on sale, you are more likely to do well in the long run than if you buy stocks when they are overpriced. It is a painfully obvious insight. But it is also an incredibly controversial one. People have threatened to kill me if I share this insight with people. I have been banned from three different discussion board communities for sharing this insight with people. Do you know anyone else who has been banned from three communities without once being charged with violating a posting rule? I think that one should be in the Guiness Book of World Records. There are lots and lots of investors who have a good bit of emotion wrapped up in being sure that no one ever hears this insight or the proof for it that exists in the historical data. It is a powerful insight, but it is powerfully offensive to the many investors who have ignored it when setting up their investing strategies.

You are always better off to pay less than fair value for a share of stock than to pay more than fair value. William Bernstein says that this is so as a matter of "mathematical certainty." The conventional methodlogy studies are rooted in the assumption that this mathematical certainty is false. That's why Bernstein says that the conventional SWR studies are "highly misleading."

I have no objection to people using the conventional studies to plan their retirements if they please. What I say is that, if we are going to permit discussion of analytically invalid studies, we should also permit discussion of analytically valid ones. It is only fair, especially given the fact that the errors made in the conventional studies are likely to cause thousands of busted retirements in days to come.

We are always going to have a mix of complex and simple at this board. The numbers stuff is complex, there's no getting around it. But no one who has a hard time taking in the numbers stuff should feel intimidated about joining in on discussions on the non-numbers stuff. It is hard for me to imagine that there is anyone in the community too much less skilled with numbers than me. I often find it a struggle to remember my telephone number! I am not intimidated by the numbers stuff. I love JWR1945 for doing the work, Without him, this machine wouldn't run. But I just chime in when there is a non-numbers point to be made and shut up when him and Gummy are talking in that strange language they use with each other.

We need Gummy and we need JWR1945 and we need some more numbers guys too. BenSolar, where are you? Raddr, where are you? We need non-numbers guys (and gals) too, though. This is what community is all about. We all give what we have to give and take what we need to take. We learn together. That is the name of the game not just at this particular board but in the larger community of which we are a small part too (when people are thinking straight).
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Post by hocus2004 »

Hocus your just not getting it.

I get it just fine, ES. I don't like he sound of some of what I am "getting."

I bust my butt at this place seven says a week trying to bring in new posters. I brought in a good one the other day when Petey started posting here. An old pal of yours, Bookm, put up a totally unprovoked attack on him combined with a threat that there would be more of the same if Petey ever were to dare question any of Bookm's views in the future. I have seen scores and scores of Peteys leave boards in the past (including this one) when they were given that sort of treatment. I don't want us to suffer more of those losses, so I worked up a little bit of courage to call the abusive poster on his nonsense and ask him to kindly knock it off.

I also "get it" that you lack the courage to do the same, ES. Well, that's too darn bad. It's your job. That's what site administrators do. When you invite people to this place, you provide them with a copy of the rules that are supposed to apply here. Those who join up have every right to believe that those rules will be enforced in some sort of reasonable way. You have failed to do that in the past and you are failing to do it now.

When I asked for help with the Bookm matter, your response was that you don't get involved in that sort of thing, that the posters have to work it out for themselves. When I called Bookm on his nonsense, we saw a very different response from you. In that circumstance we saw threats of board bannings. Why the difference? It's because Bookm is an old pal of yours and Petey is not. So attacks on Bookm are acceptable stuff but requests that Bookm follow the rules are grounds for a board banning.

You are not playing it straight, ES. And people of course see this. All of the lurkers who are trying to make a decision as to whether to post here or not watch what you do to help inform their choice. Your say all sorts of nice things in the post you put up at the Community Forum board. But those nice words are not translated into action. Bookm violated those rules and you had not a word to say to him about it. I did not violate those rules and you threatened to ban me from the board.

It's a double standard. There is one set of rules for old pals of yours and another set for just ordinary posters. If you are going to have a double standard like that, then you need to tell people about it when they sign up. You need to put language in the rules telling people who are the chosen ones who get to set the terms of discussion on the boards and who are the second class citizens who have to go along with whatver the chosen ones say. Do it that way, and people can make informed choices as to whether to participate or not.

I will elect not to participate at any board that follows such a policy. I like Bookm just fine. But I can't put confidence in anything Bookm says unless what he says is subject to question by other posters. Bookm made a public declaration yesterday that he will not permit his statements to be subject to questioning. So you have taken from me not only the possibility of hearing Petey's take. You have also taken from me the possibility of getting the benefit of Bookm's take. A take that cannot be questioned is not worth much. And you have also taken from me the chance of hearing the takes of all the posters who watched what happened to Petey and who won't be paying us a return visit as a result.

It's not a perfect world but most of us don't have any problem with this philosophy

I doubt that there is a single member of the community who has any problem with the philosophy. The philosophy is a "live and let live" philosophy. That is a perfectly sensible philosophy.

The problem is with the implementation of the philosophy. The way you implemented it with Bookm was with two rules: (1) Zero consequences for old pals who violate the philosophy that the community wants to have apply; and (2) the death penalty for any poster who calls that poster on his nonsense. The philosophy is just fine. Your implementation of the philosophy is completely lame. Your implementation of the site rules has hurt us a lot in the past and is hurting us now. You should stick with the philosophy you have detailed in your post, but you should start implementing it in a reasonable manner. That's your job.
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Post by unclemick »

Keep it simple - buy the Vanguard Target or Lifestrategy fund nearest 4% yield - Income nowadays(20% stocks) and switch/blend funds when you can get 4% with higher stock component.

Not precise - but might have some merit handgrenade wise.

Note that at extremes - even the income series is below 4% today and had they been availible in 1973-4 even the highest stock % fund would have exceeded 4%.
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ElSupremo
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Post by ElSupremo »

Greetings hocus :)

Ok so you get it. But IMHO the big picture continues to elude you in this case. From now on when I see stuff in your posts that may confuse others on this issue I'll just post this link:

http://nofeeboards.com/boards/viewtopic.php?t=3352

That way they will simply see where NFB stands on this matter.

BTW I do appreciate your concern and input. So I'll tell you what, let's just agree to disagree on this one. ;)
"The best things in life are FREE!"

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Post by hocus2004 »

I do appreciate your concern and input. So I'll tell you what, let's just agree to disagree on this one.

Of course.

We are on the same side, ES. I want to see the site succeed and you want to see the site succeed. Perhaps over time I will come more to your way of seeing things and perhaps over time you will come more to my way of seeing things. Perhaps we will both continue to see things the way we now do. That's not the important thing. The important thing is that we are both working to achieve the same goal.

I hope that there is no one in the community who believes that anything I have ever said on any of the boards was in the nature of a personal attack on any other community member. I have disagreements with ES, but they are not personal in nature. I have disagreements with intercst and raddr and ataloss, but they are not personal in nature. Not even a tiny little bit.

I will work with the devil himself (don't tell my priest I said that!) if that is what it takes to make these boards succeed. I can work with anyone because things that people say of a personal nature about me mean nothing to me. My focus is 100 percent on the success of the boards. What others say has influence on me when they construct the argument to highlight the benefits they see to the boards coming from their proposed approach. Personal stuff I pretty much count as zilch, or in some cases that can be a negative factor (where I see it hurting the boards).

You obviously want the board to succeed, ES. So it is obvious to me that we are on the same side. And of course there are many things that you have done that I think were right as well as a few that I think were wrong. The goal is ultimately to bring this to the place where both of us want to bring it. I am absolutely confident that we are both working towards the same goal, although obviously coming at it from different viewpoints as to what is most likely to get us there.
JWR1945
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Post by JWR1945 »

MacDuff wrote:...Say one is absolutely convinced that varying his/her allocation to stocks according to PE10 is a great idea.(I am so convinced.)

Given that , what is the algorithm for making the switches? It shouldn't take more than 4 sentences to give it. I keep coming back to this board attracted by the obviously intelligent and helpful people who post here. But then I always go away, convinced that no one is going to part with the magic formula. Maybe it could be succinctly stated and placed in a sticky folder, so anyone could get quickly up to speed about what is being debated here.

PS I just read a lot more stuff, and I see that perhaps as yet you don't have a protocol-"If this, allocate that". I just read through a long piece on "A Sanity Check". If I understand that correctly, you choose a lower boundary below which you allocate 100% stocks, and an upper boundary above which you own no stocks. Between these you use one "intermediate allocation", which in your examples has been 30,50, or 70%. If I understand correctly, you haven't used finer divisions within the intermediate category. Is this correct?

Mac
This is the closest that I can come to a single direct answer. I was surprised to find that this is on page 6 of 7 in the SWR Research Board's contents.

TIPS Switching Surveys dated Tue Mar 09, 2004.
http://nofeeboards.com/boards/viewtopic.php?t=2208

Pay special attention in my warnings about relying too heavily on the exact numbers. That tells us about the past. Expect the future to be a little bit different, but similar.

The best allocation when P/E10 is very low turned out to be 100%. The best when P/E10 is very high turned out to be 0%. Even so, hocus2004 has made a good argument for holding some stocks in retirement portfolios at all valuations and never holding 100% stocks even when they are bargains.

Here is the overview post in the thread. It has most of what you want in a relatively short post.

Have fun.

John R.

P.S. Historical Database Rates are what we would now call (30-year) Historical Surviving Withdrawal Rates.
JWR1945 wrote:TIPS Switching Surveys: Overview

These are the optimized results for switching allocations with stocks and TIPS with a 2% (real) interest rate.

I used the TIPS version of my latest modified Retire Early Safe Withdrawal Calculator, JanSz-Chips Deluxe V2.0B TIPS. It allows you to set four P/E10 thresholds and to adjust three out of five stock allocations. When P/E10 falls below the lowest threshold, the stock allocation is always 100%. When P/E10 is above the highest threshold (as it is today), the stock allocation is 0%. Earlier investigations had shown this result always to be true.

Optimization turned out to be much more difficult than I had anticipated and my progress was awkward. I am satisfied that I have come reasonably close to the true optimal values. I am satisfied that the highest Historical Database Rate of 5.2% is a consistent ceiling using simple P/E10 thresholds. I am satisfied that the best reason for using additional thresholds and allocations is to reduce the sensitivity of results to minor differences from the optimal values. That is, I expect that the optimal values in the future will be similar to those extracted from historical data, but not identical. My goal is to reduce the effects of errors because we are depending upon historical data.

Conditions

All results are for retirement periods starting in 1921-1980. All portfolios consisted of stocks as represented by the S&P500 index (with all dividends reinvested) and 2% TIPS. Expenses were 0.20%. Portfolios were re-balanced annually at zero cost.

The Historical Database Rates reported here are the highest withdrawal rate:
1) that would have produced a positive balance for an entire 30-year period,
2) but which would have had a negative or zero balance in at least one historical sequence (beginning in 1921-1980) when the withdrawal rate was increased by 0.1%.

Withdrawal rates are in terms of the portfolio's initial balance. All withdrawal rates are in increments of 0.1%. Withdrawal amounts were adjusted to match inflation. The interest from TIPS also matched inflation and they decreased during times of deflation. TIPS were treated as trading vehicles without any capital gains or losses and there was never any adjustment back to par at maturity. Inflation was measured according to the Consumer Price Index for Urban workers (CPI-U).

P/E10 is the current (real) price of the S&P500 index divided by the average of the previous ten years of (real) earnings. This indicator of valuation (P/E10) was developed and is reported by Professor Shiller of Yale.

Summary

The best Historical Database Rate was 5.2% in all cases. It was never possible to reach 5.3% without several failures.

The simplest approach uses two thresholds and one adjustable stock allocation (for a total of three). The best choices are P/E10 thresholds of 11 and 24 and stock allocations of 100%-30%-0%, respectively.

When there is more than one, the most important thresholds are the lowest thresholds.

The best choice with three thresholds and two adjustable allocations (for a total of four) is to use P/E10 thresholds of 9-13-24 with stock allocations of 100%-50%-30%-0%, respectively. [Results with 100%-60%-30%-0% allocations and P/E10 thresholds of 9-13-24 are almost identical. Using P/E10 thresholds of 9-12-24 is another a good choice.]

The best choice with four thresholds and three adjustable stock allocations (for a total of five) are 9-12-21-24 or 9-13-21-24 (with no preference) with 100%-50%-30%-20%-0%, respectively. There is relatively little sensitivity to changing the lowest adjustable allocation or the lower middle P/E10 threshold.

Have fun.

John R.
JWR1945
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Post by JWR1945 »

MacDuff wrote:
JWR1945 wrote:The following numbers are in real dollars. That is, they are adjusted to match inflation. Withdrawals of 4% mean 4% plus inflation. If inflation is 3%, the withdrawal amount totals 7%.
Hmm. I must not understand the way you are using these rates. With my math, if one is using a 4% withdrawal rate, and that first year experiences 3% inflation, his withdrawal rate in the next year, to maintain real consumption would 4.12% rather than 7% of the original portfolio.

For example using a $1,000,000 portfolio, and a 4% real withdrawal rate, one would take $40,000 the first year,Y0. Then in year Y1, he would need $40,000 +(3%*40,000), or $40,000 +$1200 = $41,200. Dividing this amount by our index portfolio value of $1,000,000 gives a second year withdrawal rate of 4.12%.

Am I confused here?
mac
No. You got it right.

Thanks for correcting my mistake.

Have fun.

John R.
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Location: Centralia, WA

Post by MacDuff »

JWR1945 wrote:This is the closest that I can come to a single direct answer. I was surprised to find that this is on page 6 of 7 in the SWR Research Board's contents.
John R.
Perfect! I think this clarifies it for me very well.
Thanks :)

mac
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