ben wrote: Yes one of my issues with current calculators is that they do not give us the chance to see how things would have worked out with a more modern portfolio structure - be it reits, commodities, PM, foreign equity, foreign bonds Etc.
There is of course a good reason for that; we do not have nearly as much data - even though raddr does some good footwork studies on adding commodities and foreign on raddr-pages.com:
As you can see, adding EAFE made a huge improvement in the historical SWR numbers. In fact, substituting EAFE for the S&P500 added a whopping 1.2%/yr. to the SWR, a > 30% improvement. A 50:25:25 mix of EAFE: S&P500 :Comm. Paper was not far behind at 4.9%.
Will international diversification help us going forward? We won't know the answer for a long time but I suspect that the value of international diversification may even be greater going forward. This is because for most of the past few decades neither the S&P500 or the EAFE were valued particularly high or low relative to each other. Now, however, the relative valuations have diverged and the S&P500 is trading at significantly richer valuations relative to the EAFE. I think that for this reason the EAFE has the better prospects in the next few decades. I'd be very leery of letting the equity portion of my retirement portfolio ride 100% on the S&P500 or TSM (Total Stock Market) index.
And the commodities conclusion:
http://raddr-pages.com/Retire%20Early%2 ... utures.htm you can scroll to the bottom for the conclusion. This would has a portfolio including both commo/sp500/scv/foreign/tips opf 20% each with a HSWR of 5.7%.
Again; as raddr points out in the text there is limited data for some of these asset classes and it does not predict the future - but to ME it does give me some usefull knowledge.
Cheers!
Hi Ben,
This is only partly true.
To use quick'n'dirty example:
S&P 500 at P/E over 20 today.
Dividend 1.8%
Real historical S&P 500 growth 1.8%
(inflation 3.2% historically, total return 5% historically)
BTW, here we're not saying we know the future growth, we're saying companies over time have produced 1.8% real growth. This has been lower in the high inflation eras like the 70s but even then companies produced 1.1% real growth. The 70s did poorly because investors bid stocks down from P/E 15.5 to 7.5, not because earnings didn't keep up with inflation as is I think the common perception.
Lastly, P/E mean revision to between 14-16 (depending on whose mean valuation you accept - Bogle said 14.1x in his
Common Sense book but more recently has said 16 like Grantham). Depending over what period you compress the priced - average has taken one decade to mean revert - this affects your long-run return by varying amounts.
The studies and calculators work on the basis that the S&P 500 produced 6.3% real from 1900-2004, but that a good chunk of that was lost due to selling underwater shares some of those years. This reduces the return to say 4.75% real and holding a proportion of bonds delivered maybe 2% real & mix those together and you get 4.06%. This is rough and dirty.
How useful is this today? Answer, not much. Why?
S&P 500 Dividend 1.8% + 1.8% Real growth +/- P/E expansion/contraction. If compacted over a 30 year payout, you lose 0.74% with P/E contraction (original studies use 30-year payouts).
S&P total real return (pre-tax): 2.86% real.
What one has to bear in mind is two things. Firstly one lost around 1.5% of real return due to selling underwater stock during past studies, even with bond diversification. The above 2.86% gordon equation result takes today's valuations, mean reverts them over three decades, but assumes no loss due to selling underwater from your starting FIRE position. This of course is not realistic as the studies do show. You lose something to having sell something every year for expenses. We can be smarter about allocations and avoid selling more often as I have indicated and more diviersified portfolios work to that end, but you'll still lose something. Being very generous we could say we only lose 0.50% instead of 1.5% for selling underwater. This reduces the S&P 500 real return over next 30 years to 2.36% real. This also assumes me don't have any high inflation periods where companies struggle to obtain the 1.8% real growth - we skirt over that possibility too. Also ignores fees. So overly optimistic assumptions and real returns a sad 2.36% real (pre-tax).
Substituting other asset classes for more balance will work, but their starting valuations in each case make a big difference as the S&P 500 clearly shows. The lack of P/E expansion which has padded returns over the years and the 2.7% lower dividend vs 4.5% historical dividend yield for the S&P 500 is the other component to why returns are so poor. However, one needs to run a gordon equation analysis as above in order to determine how something like the EAFE index might deliver.
EAFE Index growth approx. 1.5% real + 1.83% dividend - 0.55% P/E contraction (P/E 18.85 to 16 over 30 years) = 3.88 real. This excludes loss due to selling underwater. So call it 3.38% real. Mix EAFE and S&P 500 together and you get 2.87% real.
The problem though is that you've made a lot of optimistic assumptions there. Both ignores fees. One will need the value premium or the small premium - or both - to come out ahead and post real returns anywhere near 4% via indexing. Mixed with bonds, etc., this still won't get your 4% real. The numbers just don't add up.
Just as an aside, TIPS over 30 years using 10-year TIPS and reinvesting get an estimated 4% real with little taxes and cuts out volatility due to holding to redemption. This is why I think this is attractive as one asset in a collection of assets. I would drawdown over 40 years to ensure they lasted the remainder of the my lifetime, but given market levels TIPS/I-Bonds certainly have attractions on a returns-basis. Down the line we may again see value investments posting near or double-digit real returns but as things stand today we should pick assets in the distribution phase that give the best return for a given level of risk. On a risk-adjusted basis (whether you consider risk to be volatility or risk to capital), TIPS are very attractive held individually (not in a fund) and spent down.
Petey