This is a brief study of the sensitivity of portfolio lifespans to withdrawal rates when there is switching. The older Historical Database Rates were extremely sensitive. A increase of 0.2% reduced the portfolio duration by a decade (or worse) at high levels of safety (95% and above). This sensitivity disappears when we use portfolio switching.
Study Conditions
I looked at switching between 80% stocks and 20% stocks based on P/E10 with a threshold of 12. The higher stock allocation (80%) applied whenever the P/E10 was less than 12. The lower stock allocation (20%) applied when P/E10 was equal to or greater than 12. The alternative investment was TIPS with a 3% interest rate. The expense ratio was 0.20%, which is reasonable for an S&P 500 index fund, but which is high for the TIPS. I used a modified version of the Retire Early Safe Withdrawal [Rate] Calculator (Version 1.61, November 7, 2002). My modification makes TIPS the alternative asset class when switching. The original version used commercial paper.
Otherwise, I used default values.
I restricted my analysis to the years 1921-1980 to avoid a data anomaly.
Results
These are the number of failures on or before the number of years indicated for various withdrawal rates. Switching is between 80% stocks (below threshold) and 20% stocks (at or above the threshold). The P/E10 threshold is 12. The alternative investment is TIPS at a yield of 3%.
Code: Select all
Rate 20 25 30 35 40
4.0% 0 0 0 0 0
4.2% 0 0 0 0 0
4.4% 0 0 0 0 0
4.6% 0 0 0 0 0
4.8% 0 0 0 0 1
5.0% 0 0 0 2 10
5.2% 0 0 0 11 15
5.4% 0 0 7 14 16
5.6% 0 0 13 17 17
5.8% 0 5 16 18 19
6.0% 0 8 18 19 20
The combination of switching and TIPS eliminates the extreme sensitivity of portfolio duration to the withdrawal rate.
Have fun.
John R.