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Is relying on US / FIRECalc data reasonable?
Old 11-08-2009, 09:46 AM   #1
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Is relying on US / FIRECalc data reasonable?

Original version of this post was a reply in a Monte-Carlo thread but then I thought it deserves its own thread since it deals more with relying on US history and FIRECalc than Monte-Calro simulation. I also padded it with more ideas...

I had this thought for a while as I was reading through various posts on this forum. People often express an opinion that starting with FIRECalc is a good thing and that while FIRECalc is not perfect, is goes through all the "bad" times and therefore should give one a sense of security or at least good starting point. Please note that I think the world of FIRECalc, but I am very concerned about it using US historical data and not other countries historical data (perhaps for the lack of it??)

Here is a couple of scenarios:

(1) In another thread someone posted their assumption of 10-12% yearly return based on relatively recent data (perhaps from before recent crash). People thought it was unreasonable. Even though the person was using historical data, people said it was not enough (presumably because the period was too short of a 20-30 year period to rely on).

(2) If I told you there is a new version of FIRECalc. It would look only at the best 30 years in US history and give you the output based on that, would you use it? I am sure the answer is "no way".

So, my point is that using FIRECalc just based on US-based data has exactly the same issues as above two scenarios. You are effectively picking the best place to invest in the world and starting from that record of 130-or-so years. It may seem like depression, long stock-no-return periods, and "high" inflation of 70's provides for some bad times to test your portfolio; but I would think it does NOT. You are still picking a combination of best returns over the last century in the country which economically ended up at the "top of the world". You are effectively starting with BEST record out there, which is analogous to scenarios (1) and (2) above.

Do you really believe your results would be the same as the second largest GDP county (Japan)? I don't mean to get into debate on how US is not Japan. My point is it could even be worse than Japan going forward or it could be better - we simply don't know. What about Europe, Russia, and yes even 3rd-world countries? One might even say coming from 3-rd world status to something better could provide for higher returns than starting already at the top like US...

Also note that US had not gone through 20%, 30%, 100%, and 1000% inflation periods that seem to appear on a regular basis all over the world.

Now, some people would say why plan for "Armageddon"? If such scenarios happen, we are all dead. But the truth is all those countries are very much alive. People live through these events and still go on having to feed themselves, etc. Yes it hurts financially, and so if you are trying to "test" your retirement portfolio plans, why would you want to start with with the easiest test, i.e. the US?

Next point: for all the indexers out there (including myself to a degree), your core belief is that history of a person's picks does NOT predict his/her future performance because even if there is skill out there, it's too hard to know who is lucky and who is skillful... and in this case we are talking about skills of a person. Now, do you think history of a country predicts its future developments? Will countries that did well in one 30-year period do well in the next one? How about one century vs next? Is there any proof?

Next, I can hear someone saying: well, all you can do is stay flexible and be willing to return to workforce in worst case, and indeed this might be the only remaining option... But the point is you have to realize that stresses you put on your portfolio when relying on US history are simply in all likelihood not realistic. Even though you pad 4% SWR and say you can rely only on 3% or 2% does not mean you would be as comfortable doing so if you realized that your starting point should have been 1% SWR to begin with... Put another way, it seems very similar to saying "I will have 10% SWR and if it does not work out I will return to work". Yes, you can do that too.

Next point: US data will mislead you into percentage of equities to have in your portfolio. Again looking at Japan like returns - I would guess 0% stocks might have been the best option there in the last 20 years. No idea about 100 years though. But in any case, relying on unique US market returns seems like it might be misleading.

Here is an interesting quote from the original thread:

Quote:
Originally Posted by rmark
'I wonder what the results of a FIRECalc type analysis would be if instead of using US data one were to use say Germany's or Japan or heaven forbid Argentina!'

Actually, I took the indiviual countries data 1900-2000 from 'Triumph of the Optimists' and ran it through the moneychimp.com monte carlo demonstrator using a 60% stock/40% bond portfolio and an initial 4% withdrawal from a $1,000,000 over 25 years.
Germany (ex-weimar republic) had a 40% success rate, Japan 42%, but no Argentina. Italy was the low at 35%. The US success rate was 83% , probably due to the slightly lower returns the book lists.
Also, here is a quote from Buffett in his 2005 letter to shareholders: "It’s been an easy matter for Berkshire and other owners of American equities to prosper over the years. [...] To get very specific, the Dow increased from 65.73 to 11,497.12 in the 20th century, and that amounts to a gain of 5.3% compounded annually. (Investors would also have received dividends, of course.) To achieve an equal rate of gain in the 21st century, the Dow will have to rise by December 31, 2099 to - brace yourself - precisely 2,011,011.23. But I’m willing to settle for 2,000,000; six years into this century, the Dow has gained not at all."

Now adjust the this observation from 2005 to today...
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Old 11-08-2009, 09:59 AM   #2
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Jim C. Otar addressed many of the thoughts you posed. For example, he did FIRECalc-like runs for other countries (I believe Japan, Canada, UK and Australia). Have you read his book Unveiling the Retirement Myth?

We've had a couple of threads on Otar's book, have you looked at them? Have you used his retirement calculator?
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Old 11-08-2009, 10:44 AM   #3
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So what's your alternative?

No system is perfect and using historical data definitely isn't perfect.

But I find it better than a crystal ball.
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Old 11-08-2009, 10:55 AM   #4
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@LOL!: Thanks for the reference. I searched for Otar in thread subjects and found 1 thread, started by you. I remembered that I had read it already but looked through it again. I don't see my concerns addressed in that thread. From the thread it looked like Otar still assumes S&P data, still talks about 3.5-4% SWR, and from his site FAQ it seems like he assumes US inflation data. I did not read Otar's book but have it on my todo list based on that thread (thanks!). In any case, can you summarize the conclusions or responses to my concerns as you understand them addressed in his book?

@kiki: I don't have an alternative, but "stressing" your plans with improper data sounds like not a very good alternative either - maybe worse than the crystal ball? I am hoping for some thoughts / discussion on what an alternative could be. Also, at least these thoughts may cause some to be more conservative or reevaluate plans.. Based on LOL! response, it sounds like someone researched these questions already with studying other countries too. Perhaps others have looked into this and have some good thoughts that I would love to hear.
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Old 11-08-2009, 11:12 AM   #5
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A lot of bad things could happen. A lot of great things could happen.

None of us will live forever. Death is a certainty. Its impact and even its timing can be forecast with a lot greater precision than any of the economic calamities you've mentioned. Given this, one of the "bad things" that can happen to an individual is to let fear of future events paralyze them into inaction. They spend an extra three decades in a cubicle because they convince themselves that the future is unknowable, they must plan for te worst, and they settle on an investment in a diversified basket of government bonds from around he world, gold coins, and ammunition with a return of 1% per year. And they decide only a 1% withdrawal rate is safe.

There are no gaurantees, only estimates of risk.

You might enjoy Bernstein's classic "Retirement Calculator from Hell Pt1" and "Part II" and especially Part III. From Part III (Emphasis in the original):

Quote:
Let’s examine a small sampling of possible political, economic, and military failure modes:
  • The mildest scenario is that of catastrophic inflation, as experienced in Germany and Hungary in the 1920s or, more recently, in much of the developing world.
  • Political failures are slightly worse, since these threaten the basic human motivation to work and produce. The state, for whatever reason, can decide to confiscate your assets or, worse, society’s means of production. Anyone who judges this unlikely should turn on CNN during any G-8 or WTO conference.
  • Local military action. Probably the lowest-probability item on this list, but something to think about on other continents.
  • The Big One: Some deranged prime minister or colonel in central Russia, Pyongyang, or South Asia could let loose the four horsemen upon the planet.
So, think about what a 97% 40-year success rate means: the absence of all of the above for approximately the next 1,200 years. (A 97% success rate means a 3% failure rate; those 40 years divided by 0.03 is 1,200 years.) Ignore for a minute the uncertainties of the less-developed world and think only about the winners: Germany—in this century alone, three episodes of military and/or economic disaster, the first two associated with mass starvation. Japan—wartime devastation even worse than Germany’s. England—near brushes with disaster in 1812-1814 and in both world wars. And even the United States—repeated banking failures, civil war, and the near-bankruptcy of the Treasury in the 19th century. The near collapse of the capitalist economy in the 1930s. And oh yes, I almost forgot—the entire globe barely missed mass incineration in October 1962.
History’s best-case scenario was the Roman Empire, which survived more or less intact for about seven centuries (if you ignore the odd sackings of the capital after 200 A.D.).
A wildly optimistic historian might give us another few centuries of economic, political, and military continuity. Back-of-the-envelope, that’s about an 80% survival rate over the next 40 years. Thus, any estimate of long-term financial success greater than about 80% is meaningless.
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Old 11-08-2009, 11:19 AM   #6
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Originally Posted by smjsl View Post
Please note that I think the world of FIRECalc, but I am very concerned about it using US historical data and not other countries historical data (perhaps for the lack of it??)
Now adjust the this observation from 2005 to today...
You've done a great job of pointing out the problems without any suggestions for solutions. Essentially you're saying that the historical method is flawed because it doesn't have the right kind of history.

Have you read Bernstein's "Calculator from Hell" articles? Even if you get the data set of your dreams (two millenia of global investment returns plus the GDP summaries of the civilizations on Mars, Deneb, and Betelgeuse?) that data may still be going into a flawed algorithm. It certainly won't make you feel happier than using FIRECalc's Shiller data... it might suggest that even a 2% SWR is too aggressive.

We can ignore the historical method completely and try predicting the future with gurus (Soros, Buffett, Taleb, Cramer, Blodgett, Meeker) or with more quantitative analysis (the Gordon equation).

Or we could ignore both past & present while going for one of the following: living off dividends, semi-retirement with part-time work, Harry Browne's permanent portfolio, Bud Hebeler's "Analyze Now!" annual-feedback method, or Milevsky's annuitized "human capital" method plus Social Security.

Don't get me started on the various asset-allocation schemes. We haven't even decided what rate of return is appropriate, let alone how to get there.

Frankly it could all scare you into working for the rest of your life. I guess the "upside" is you'd be so miserable that your working life wouldn't last very long.

ER planning also has a significant emotional "sleep at night" component that FIRECalc will only satisfy in INTJ engineers. I think FIRECalc attains a reasonable hand-grenade approximation of accuracy (never mind the precision) while pointing out any big ugly flaws. Beyond that it's a matter of building in a reasonable margin of safety and being ready to adjust future spending to future economic conditions.

Or moving in with your kids...
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Old 11-08-2009, 11:21 AM   #7
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@samclem: The point I come back to is I am not looking for worst-case assurances. I am saying that to start with average estimates of future, you cannot start with US statistics. US history is "best", not "average". So, when you make your plans based on US history, you are biasing your results just like the person relying on 10-12% return based on his "best-years" historical selection.
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Old 11-08-2009, 11:28 AM   #8
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ER planning also has a significant emotional "sleep at night" component.
Exactly, and relying on data that requires Dow to be at 2million+change at the end of the century (and today it's less than that "change") does not give me a good night sleep... so I wonder why it does for others :-)

For me personally, I would be more comfortable with FIRECalc taking all that non-US history into account.
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Old 11-08-2009, 11:56 AM   #9
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@samclem: The point I come back to is I am not looking for worst-case assurances. I am saying that to start with average estimates of future, you cannot start with US statistics. US history is "best", not "average". So, when you make your plans based on US history, you are biasing your results just like the person relying on 10-12% return based on his "best-years" historical selection.
Well, if you are bothered by the possible problems of using US data only, I've got another thing we can worry about. Maybe it is just as illogical to fixate on data from just the last century or so. After all, who's to say that this is typical of what things will be like in the future? So, let's broaden the scope a little and include more data. What has per capita GDP growth been across a few centuries? (Illustration taken from "The Birth of Plenty")


Holy Cherry-Picking, Batman! We've only been looking at the most prosperous century the world has ever known! If we look back over the previous 20 such periods none have seen growth rates even close! We're crazy to use this data! So, there it is: If you want to use the whole world, and you want to look at other periods, get out your scale and magnifying glass and try to figure out a growth rate from the chart above. I'd guess it will average less than 1%, and we have a solid period of 1000 years of negative growth in per capita GDP. I think the idea of ER is pretty much off the table.

IMHO, including the recent historical performance of Zambia and Myanmar in your data sets to try to determine the next 40 years of growth in the US and other developed economies makes as much sense as the exercise above. There are basic structural differences (political, social, and economic) that make the nations, and the likely performance of their economies over the next few decades, very different.
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Old 11-08-2009, 12:42 PM   #10
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Why test with U.S. data? Why test with Argentina data or German data? We are in the U.S., our history mirrors our political and monetary system. Our data mirrors the way the people of the U.S. have reacted to financial simulations in the past. If you expect major changes in the way the government is going to act and you believe that the reaction to changes in the economy are going to mirror Japan, then by all means use Japan.


Off topic ramble to follow:
I am comfortable with FireCalc's handling of recessions and recoveries, however, hyperinflation is another matter. Hyperinflation is something I have read little about. I don't know what the average German or Argentinian did to survive. It would seems that those that owned appreciating assets would do OK, and the worst thing you could hold would be currency. Those working would, one presume, see increases in there pay, however, I am not sure it could really keep up with hyperinflation. I would think stocks would keep up as they have the ability to change price instantaneously. Non cola'd pensions would be worthless, and I would guess that most cola'd pensions would adjust too slowly to help unless the government stepped in and changed things.
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Old 11-08-2009, 12:53 PM   #11
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Off topic ramble to follow:
I am comfortable with FireCalc's handling of recessions and recoveries, however, hyperinflation is another matter. . . I would think stocks would keep up as they have the ability to change price instantaneously.
No, usually stocks don't do well in countries experiencing hyperinflation. While you are right about stocks being able to be instantly revalued, the problem is that hyperinflaton is so disruptive of trade and economic activity that the earnings and profitability of companies goes into the toilet. Without profits, stocks go way down in value.

Foreign stocks usually aren't much help: Governments undergoing hyperinflation usually clamp down on the ability to buy them.
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Old 11-08-2009, 01:02 PM   #12
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I share smjsl's concerns in the OP and I think that it is a very worthwhile topic in that if one relies entirely on a firecalc type analysis it can give a false sense of security. That 100% survival rate for my portfolio is wonderful to see but thanks to reading the calculator from hell series I got what I think is a more realistic perspective of the whole process.

The practical application of that line of thought for me was to chose my ER "style" to match those concerns. i.e. retirement in a semi rural area with abundant natural resources (firewood, water, mild climate), low population density, a comfortable but definitely LBYM lifestyle and absolutely no debt.

Is all this absolute protection? of course not nothing is or can be. But I can certainly tell you that my worries are reduced from what they would be if I were living in large metropolitan area, enjoying my 5% withdrawal from an all equity portfolio while making large mortgage payments on my McMansion and paying the minimum on my large credit card balances.
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Old 11-08-2009, 02:26 PM   #13
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...the Dow increased from 65.73 to 11,497.12 in the 20th century, and that amounts to a gain of 5.3% compounded annually...To achieve an equal rate of gain in the 21st century, the Dow will have to rise by December 31, 2099 to - brace yourself - precisely 2,011,011.23.
On a scale like the DOW the numbers seem daunting because doubling 1,000,000 to get to 2,000,000 just seems different than doubling 5000 to get to 10,000. All we would need to do to make things "seem" more manageable would be to re-normalize the scale every decade or so. If the keepers of the Dow simply re-normalized it from 10,000 to 1,000 it wouldn't seems so daunting to gain back 400 points to get back to our previous high For you English majors out there - is re-normalize really different than normalize?
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Old 11-08-2009, 02:33 PM   #14
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@LOL!: Thanks for the reference. I searched for Otar in thread subjects and found 1 thread, started by you. I remembered that I had read it already but looked through it again. I don't see my concerns addressed in that thread. From the thread it looked like Otar still assumes S&P data, still talks about 3.5-4% SWR, and from his site FAQ it seems like he assumes US inflation data. I did not read Otar's book but have it on my todo list based on that thread (thanks!). In any case, can you summarize the conclusions or responses to my concerns as you understand them addressed in his book?
In the Chapter that Otar spends on diversification he has 4 fictitious persons, from Canada, UK, USA and Japan. Each person invests predominantly in their own country and holds index funds in overseas countries (FTSE, Nikkei, etc) and he tries a variety of asset allocations and international spread.

His conclusion is that asset allocation has a much bigger effect on long term returns than on diversification, and that international diversification makes a surprisingly small difference.

He says
Quote:
Deep down I believe in the benefit of diversification especially across different asset classes. However, it appears that diversification in the same asset class and across different geographies does little good, other than perhaps in the short term during routine fluctuations. Considering the additional currency risk I am more inclined to invest at home and not diversify too much across the globe. In my client portfolios I usually don't normally recommend allocating more than 20% of the equities to foreign content especially in buy-and-hold portfolios.
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Old 11-08-2009, 03:06 PM   #15
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So what's your alternative?

No system is perfect and using historical data definitely isn't perfect.

But I find it better than a crystal ball.
Vanguard Total World Stock Index - inception 2008.

Ya know what they say - Past Performance yadda yadda. And you don't need no stinking numbers either.

Just guts and faith that your knowledge/logic of indexing is good. Toss in some fixed appropriate for age/finanacial situation AND location on the planet. Rebalance once in a while.

When you get old - take out 4-5% of the portfolio value every year.

One more thing - don't do a lot of deep thinking.

Now is that as good as Pssst Wellesley? Only the future can tell - my crystal ball ain't talking.

So should I slip over to the Bogleheads and zing in a pssst Wellesley when no one is looking?

Hmmmm?

heh heh heh -
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Old 11-08-2009, 06:15 PM   #16
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I don't believe in MC, I just backtest starting retirement in 1929.
If I can survive the big one I feel pretty good.
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Old 11-08-2009, 07:56 PM   #17
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With all of this talk about how the statistical models used by would-be retirees are fatally flawed, you get the impression that the rest of the population somehow performs a more rigorous analysis of their financial condition and risk.

I wonder how many workers have done a probability analysis of their financial security factoring in varying stretches of unemployment. Does the average worker with no savings fare any better in Weimar Germany than a retiree with a 4% WR?

I wonder how many people relying on pensions have looked at what the withdrawal rate of their pension plan is. And then conducted a credit analysis to get comfortable with the solvency of the corporation they hope will make up any shortfall. Is there a FIRECalc type simulation to figure out the probability that your pension blows up? And does it have a Weimar Germany setting?

I wonder how many people relying on social security have done any work to figure out whether that expected federal check is actually something the federal government can afford to pay. Do you think the Weimar Republic made good on its Social Security obligations?

It seems to me the rest of the population faces risks at least as large as those faced by any member of this forum, and yet the rest of the population doesn’t obsess endlessly about whether their financial future is 100% certain. It's not. And it never will be. But then, I guess, ignorance is probably bliss.
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Old 11-08-2009, 08:22 PM   #18
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I don't believe in MC, I just backtest starting retirement in 1929.
If I can survive the big one I feel pretty good.
TJ

So your portfolio needs to survive an 80% loss at the beginning of your retirement?
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Old 11-08-2009, 11:20 PM   #19
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With all of this talk about how the statistical models used by would-be retirees are fatally flawed, you get the impression that the rest of the population somehow performs a more rigorous analysis of their financial condition and risk.


It seems to me the rest of the population faces risks at least as large as those faced by any member of this forum, and yet the rest of the population doesn’t obsess endlessly about whether their financial future is 100% certain. It's not. And it never will be. But then, I guess, ignorance is probably bliss.
Excellent point Yrs to Go. I have to believe that 90-99% of the world's population have done far far less rigorous analysis. I also suspect that a similar percentage have significantly less financial assets than the forum members.

Yet it is important to realize that literally billions of people have stopped worked and retire over the last 1,000 years ago, probably the majority have done so in the last 50 years. While its true that for many the retirement was short-live and some ended up in poverty. I suspect that most Americans and Western lived modestly comfortable retirements, with roofs over the heads, food in their bellies, and adequate clothing.

Death is the only true certainty in life.
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Old 11-09-2009, 03:18 PM   #20
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So your portfolio needs to survive an 80% loss at the beginning of your retirement?
I use the S&P 500 historical returns, not the Dow, but yea, over first
four years it drops 75%. Also test against 1973 adjusting withdrawls based
on the high inflation of course.
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