FIRECalc and the Hapless Y2K Retiree

[MasterBlaster]

First of all really good work.It is very important to realize that capital appreciation/loss of fixed income isn't included in the calculations. Not exactly a bug but returns that aren't easily replicated in the real world.
The likely capital loss of bond funds going forward are probably going to make up for the higher coupon rates.

My highest bond allocation was back in 2000/2001. I started selling bonds in 2009 and pretty much sold all bonds except for Sallie Mae inflation bonds this year. I wracked up some nice capital gains which were especially helpful in 2009 when equities tanked.

Regarding VUSTX, that is really weird fund. It only holds 29 bond issue mostly long term T-Bonds. Yet it has 105% turnover, but according to Morningstar it has very closely tracked its index. Obviously the folks at Vanguard know what they are doing regarding index, bu
t I am sure puzzled.

As how to do better than 3.5% going forward, don't discount the higher growth rates of the US economy and most importantly the huge potential for developing country. Anyway this is my bull case.

So no bonds and only US and emerging equities !

You may be right and do very well, but then again what if you are wrong ? Why bet the farm on some reasoned hunches ?

For me I'll stick with an age-appropriate risk-appropriate portfolio. The bonds may indeed moderate equity growth. But they, as usual, keep one from losing big-time.

 

[audreyh1]

I am reminded of a recent thread when people discussed investing for total return vs. income. In the long run, without producing income how can an asset appreciate?

Stock do this all the time. They may not pay out an income stream, but as company grows and increases it's earnings, the stock usually appreciates as the piece of the company the stock represents becomes more valuable. That's capital gain.

Same with real assets.

 

[haha]

The run-up in long bonds may be unprecedented, and with the interest rate having no room to go lower, I would not have any long bond right now.

I have no long bonds either, but if you think that interest rates could not go lower, how do you explain Japan?

It may be likely that US long term interest rates will not go lower, but they certainly can go lower.

 

[NW-Bound]

Stock do this all the time. They may not pay out an income stream, but as company grows and increases it's earnings, the stock usually appreciates as the piece of the company the stock represents becomes more valuable. That's capital gain.

Same with real assets.

I should have added that a corporation does not have to pay out all of its income. The market's profitability would be reflected in its P/E, which is higher than it used to be.

I have no long bonds either, but if you think that interest rates could not go lower, how do you explain Japan?

It may be likely that US long term interest rates will not go lower, but they certainly can go lower.

The US demographics is different. We do not have Japan's aging population and its xenophobic policy. And the spending habit of Americans is unsurpassed; big homes, multiple cars, etc... Spend, spend, spend...

PS. There have been more and more people questioning how the Fed is going to unwind its QE balance sheet. It's going to be interesting.

 

[clifp]

So no bonds and only US and emerging equities !

You may be right and do very well, but then again what if you are wrong ? Why bet the farm on some reasoned hunches ?

For me I'll stick with an age-appropriate risk-appropriate portfolio. The bonds may indeed moderate equity growth. But they, as usual, keep one from losing big-time.

I am not suggesting 100% equities and Europe and the commonwealth countries equities look some what cheaper than US equities.

I certainly think that everyone should have some form of a fixed income investment. A stable fund,or G fund for those of you fortunate enough to have those options. For the rest of us the 3% Penfed CDs I think are a great substitute for intermediate bonds, and I treat the 10 year 5% PenFed CD as my long term bonds. I think they provide virtually all of the upside with little of the downside risk. Unfortunately I'm bumping up the FDIC limits.

 

[jebmke]

Don't know about their historical holdings but Wellesley is 60% bonds with an average duration of 5.8 years. That may have a lot to do with the shape of the growth curve.

 

[haha]

The US demographics is different. We do not have Japan's aging population and its xenophobic policy. And the spending habit of Americans is unsurpassed; big homes, multiple cars, etc... Spend, spend, spend...

I am very familiar with these talking points. I have been an investor in Japanese equities, currency contracts, etc for years.

I still say that these are guru soundbites. How important they are as the world develops remains to be seen- thus the meaning of these things that you mention has yet to be conclusively demonstrated, thus to flatly state the meaning is an assertion, not an established fact.

I think that you are likely right, that US long term rates are unlikely to fall from here. But this is far from saying that they cannot fall from here. If they could not fall from here, there would be no be no long term bond trading on CME Group, but in fact there is a very active market.

Ha

 

[NW-Bound]

But of course there's nothing ever certain in life. We have to act according to what we think is most likely to happen. Can we do any differently?

 

[haha]

But of course there's nothing ever certain in life. We have to act according to what we think is most likely to happen. Can we do any differently?

I just feel that "cannot" and "likely will not" are very different statements. Confusing statements lead to confused thinking which leads to mistakes.

Anyway, I am not interested in 99% of the disagreements here, as they are only matters of opinion. However, this type does interest me. I have just offered evidence that a goodly number of market participants (1/2 of the open interest to be exact) are willing to back their opinion that rates may move lower, and bond futures higher.

Ha

 

[Lsbcal]

I have no long bonds either, but if you think that interest rates could not go lower, how do you explain Japan?

It may be likely that US long term interest rates will not go lower, but they certainly can go lower.

Yes, I think it unlikely but we cannot completely ignore the possibility that the economy goes poorly and we get into a deflationary period. I was just thinking today that is a partial reason for maintaining one's bond positions. In the early 1930's a bond/stock portfolio would have been preferred to a CD/stock portfolio. But intermediate not long bonds.

BTW, Japan does not have our natural resource base. Also we are more willing to experiment economically and the politically we wouldn't tolerate deflation for long. Too many memories of the 1930's.

 

[audreyh1]

I should have added that a corporation does not have to pay out all of its income. The market's profitability would be reflected in its P/E, which is higher than it used to be.

The P/E can remain exactly the same, but the stock price appreciate and thus the investment show capital gain. What happens is that the per share earnings (usually) increase with time. This is ultimately why stock indices increase over very long periods of time independently of dividends paid out.

 

[Chuckanut]

Earlier, when I said I believed in a balanced portfolio, I meant a diversified portfolio. The non-stock portion does not have to contain long bonds.

I believe that Dr. Pfau has done work indicating that stocks and SPIA's do better than stocks and bonds.

 

[audreyh1]

I believe that Dr. Pfau has done work indicating that stocks and SPIA's do better than stocks and bonds.

Later it was proven otherwise. It turned out fixed income did better. See later papers on "the glide path".

 

[NW-Bound]

Well, I tend to be a bit more casual with my choice of words. And that gets me in trouble with people who are more serious with their writing.

Anyway, on the growth of stocks, surely some individual companies will do better than others even in bad times. By picking the right stocks, some investors will manage to do well when others fail. But if the backdrop of the economy does not support the kind of growth like we had in the past, meaning the end of the Vietnam war and then the fall of Communism and the advent of computer technology, it is harder for stock investors to do as well as they did up to 2000.

What helps the Y2K retiree's portfolio was that in addition to the E rising in 1980-2000, the P had risen even more due to P/E expansion. This P/E expansion obviously cannot go on forever, and indeed stopped in 2000. And if the interest rises, P/E very well will contract.

And even if the interest rate stays low where it is now instead of going up as many expect, what will drive the bond yield lower so that bond holders can get the capital appreciation that they enjoy in the past?

Just my 2 cents...

 

[Lsbcal]

...(snip)...
And even if the interest rate stays low where it is now instead of going up as many expect, what will drive the bond yield lower so that bond holders can get the capital appreciation that they enjoy in the past?
...

The short answer is deflation.

When I did some recent FIRECalc runs for us I used a 65/35 portfolio of stocks/5yr_Treasures and our spending levels around 3.3%. So this is very specific but gives a flavor of things for 3 bad periods of depression, recession-recession-inflation-recession, and the recent 2000's :

Notice that the portfolio held up OK in the early 1930's because of bonds. I hope we never see this but we could get deflation and a bad stock market.

 

[NW-Bound]

I still have a lot of cash, which will help me out in the unlikely case of deflation.

At this point, with 3.5%WR which can be cut back if necessary and with SS as a backstop, I do not fear going broke, particularly as I do not think of living till 100 as others do.

I just do not want to see my stash going down because it hurts my psyche more than my physical well being. And there's satisfaction of successfully managing your stash so that it grows. As Soros once said, and I have to paraphrase, it shows that your understanding of the world is correct.

 

[Lsbcal]

...(snip)...
I examined the spreadsheet downloaded from FIRECalc and saw the following. FIRECalc only applies the income or dividend of the bonds to its growth. FIRECalc does not consider the appreciation of the principal when the interest drops, and the bond yield follows it.
...

The more I thought about this one, the more I worried about what FIRECalc is doing with this data. The 3 bad scenarios I mentioned above would be greatly affected by not considering the interest rate rise/fall (so called capital returns).

So I did a test for years 2002 to 2011. I looked at a pure 5 year Treasury portfolio of $1M with no spending. FIRECalc gave a final value of $1,064,095 inflation adjusted. Then I looked at what $1M would have done in VFIUX (Vanguard 5 year Treasury admiral). The final inflation adjusted value was $1,457,944 (for total return, green area below). This is a huge difference. Then I just used the income return for VFIUX (blue area below). The result was much closer to FIRECalc $1,173,121 indicating FIRECalc does indeed ignore the capital returns.

Did I do this right? Do you guys agree that this is a problem?

Here is the relevant parts of the spreadsheet:

 

[clifp]

Did I do this right? Do you guys agree that this is a problem?

Yes I think you are right and yes I really think it is a problem..
I posted a message in the firecalc support forum and I think the discussion would be better over there.

 

[Lsbcal]

Thanks Clifp. I posted a copy of my comments above over in that thread: http://www.early-retirement.org/forums/f36/firecalc-accuracy-and-future-69980.html#post1399189

 

[audreyh1]

Thanks for all the hard work uncovering this issue!!! NW-Bound and Lsbcal!

 

[adrift]

I have a spread sheet that models a Y2K retiree and the 4% rule. For investment vehicles, I chose Vanguard Total Stock Market fund and the Vanguard Intermediate Term Bond fund. I use these because they are investable and are what I would have chosen for a 2 fund portfolio.

- I use CPI from the end of each November
- I take the inflation adjusted 4% out at the beginning of each year
- I rebalance at the beginning of each year
- I use Admiral funds when they become available

The results shown are "real". The low point for the 80% stock portfolio is just under half of the starting value.

I think my Y2K retiree has a good chance of making it. At least, I hope so.

 

[REWahoo]

I have a spread sheet that models a Y2K retiree and the 4% rule. For investment vehicles, I chose Vanguard Total Stock Market fund and the Vanguard Intermediate Term Bond fund. I use these because they are investable and are what I would have chosen for a 2 fund portfolio.

- I use CPI from the end of each November
- I take the inflation adjusted 4% out at the beginning of each year
- I rebalance at the beginning of each year
- I use Admiral funds when they become available

The results shown are "real". The low point for the 80% stock portfolio is just under half of the starting value.

I think my Y2K retiree has a good chance of making it. At least, I hope so.

Wow. Registered on the forum in 2005 and your first post is in 2014? I'd ask "Where have you been?" but I already know the answer, adrift.

 

[MooreBonds]

- I use CPI from the end of each November
- I take the inflation adjusted 4% out at the beginning of each year
- I rebalance at the beginning of each year
- I use Admiral funds when they become available

The results shown are "real". The low point for the 80% stock portfolio is just under half of the starting value.

I think my Y2K retiree has a good chance of making it. At least, I hope so.

Interesting result. Thanks for crunching the numbers.

A question:

-I realize many rebalance, but I personally don't really do much of that. Are the results markedly different with no rebalancing?

 

[NW-Bound]

I know that you have many individual stock positions, so how would you do rebalancing?

I don't rebalance as much as selling stocks or ETFs that I feel have become overvalued, then look for areas that I feel is oversold to put that money into. I do keep an eye on equity AA, because I do not want to become overzealous and keep pouring money into value-trap stocks that linger for a long time without going anywhere. Lately, it has been EM, and I have to tell myself that enough is enough.