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Old 07-05-2013, 06:42 PM   #61
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Getting into the weeds now!

They model the returns using what is know as an autoregressive model. These kind of models assume that the values from the current year can be used to predict the next year, and that the next year value is a linear function of the current value. They derive the parameters for the model (I assume) by fitting it to historical data.

They start with a "seed" CAPE (cyclically adjusted PE ratio), and then assume that the CAPE changes each year using the following recurrence relation:

CAPE(t) = 2.11 + .87*CAPE(t-1) + e(CAPE)

where e(CAPE) is normalized white noise with a mean of 0 and standard deviation of 4.0 They then estimate the total stock return using this equation:

r(s) = .24 - .0083*CAPE(t) + e(S)

where e(S) is more normalized noise with a mean of 0 and std dev of 0.2.
Fred, it's great that you have the math and programming skills to analyze these data. IIRC you are in the financial services industry. I also thought something looked odd about the risks associated with different asset allocation. It is not clear to me from the link that the paper has been independently published or peer reviewed. It wouldn't be the first time that false results have been published, whether due to deliberate data manipulation or error. If something doesn't look right to informed readers, it should be questioned. Therefore I think this is one instance in which it would be quite appropriate to contact the principal author to ask for the raw data so that we (I mean you) can look it over and validate it (or not). Would you be willing to volunteer on behalf of the forum?
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Old 07-05-2013, 06:49 PM   #62
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I see you are using the formula in the paper. I follow the logic of the formula although I'll admit things like "normalized noise" are terms I'm not familiar with. So what I think you are saying is even using their formula you have trouble reproducing their results.

What I am saying is I find their reduction of the expected stock market returns from 12% to 10% (nominal) arbitrary and unduly pessimistic. Meaning my formula would be
r(s) = .26 (i.e. +2%) - .0083*CAPE(t) + e(S).

The reason being. In the 20th century the US enjoyed conditions conducive to economic growth, the rule of law, modestly regulated capitalism, political stability, and our infrastructure was not ravaged by wars or revolutions. The world as whole in the 21st century is lot more like the US back in the 20th century. Capitalism is widespread, democracy is catching on,and while there is still plenty of wars, the prospect of world wars has diminished. I therefore expect the rest of the worlds capital markets to catch up with the US rather than US markets to slip backwards.
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Old 07-05-2013, 07:09 PM   #63
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Also, don't forget William Bernstein's advice in the "Retirement Calculator from Hell, Part III" about the futility of low failure rates on long term withdrawals from a portfolio. Although I think he is too pessimistic in the article, it is general advice well worth noting:

The Retirement Calculator from Hell, Part III
Unfortunately you clipped off his closing remarks right after your excerpt. His point was that factors other than market performance may override your calculated probability of success, not that higher probability rates are "futile." Higher probability of success is beneficial unless something geopolitical or otherwise changes everything. He certainly did not mean that any financial plan over 80% success rate was pointless.
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Mind you, this is not a call for wild abandon. The above table constrains the retiree desiring a theoretical 97% success rate (of portfolio survival) from spending more than 3% per year of the initial real amount of his nest egg. Taking the accident propensity of the species into account would allow him to spend about 4%. But if you believe that we’re about to encounter a bad returns sequence or simply wish to leave a few baubles to your heirs, you’re right back to 3% again.

So live a little, and enjoy your money, for tomorrow we may be consumed by the ghosts of Hitler, Lenin, and Attila the Hun. And at withdrawals of 3% to 4% of your nest egg, don’t spend it all in one place.
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Old 07-05-2013, 08:12 PM   #64
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Me, too. I'm not advocating that people shouldn't prepare. I'm saying a few things though that I think get overlooked.

1. First, is that everyone does draw the line of preparation somewhere. That is, while you may want to be prepared in case you live to 95, do you also demand the same degree of certainty to prepare to live to be, say, 105? Or 110? ...
OK, but what I find is if you plan for a 40-50 year retirement, your WR starts to approach a 'forever' portfolio anyhow. So if I'm alive and my brain is functioning, I'll re-evaluate as I go.

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I see you are using the formula in the paper. I follow the logic of the formula although I'll admit things like "normalized noise" are terms I'm not familiar with. ...
They need to thrown in a term to adjust for the Boltzmann Constant

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Old 07-05-2013, 08:15 PM   #65
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1. First, is that everyone does draw the line of preparation somewhere. That is, while you may want to be prepared in case you live to 95, do you also demand the same degree of certainty to prepare to live to be, say, 105? Or 110? Some people do live that long. So we all have to draw a line somewhere.
Actually, retirees don't have to have a line. Retirees with enough savings, multiple income sources and/or low enough expenses may never run out of money. Some might actually save money in retirement for charities, trust funds, grandchildren's college funds or simply force of habit.

Some retiree households do find they can live well on SS alone, especially if they retire in a low cost of living location. Then they can just invest their pensions (if they have one or more) and reinvest their investment income.
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Old 07-05-2013, 08:17 PM   #66
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Unfortunately you clipped off his closing remarks right after your excerpt. His point was that factors other than market performance may override your calculated probability of success, not that higher probability rates are "futile." Higher probability of success is beneficial unless something geopolitical or otherwise changes everything. He certainly did not mean that any financial plan over 80% success rate was pointless.
Agreed, I get tired of that being taken out of context (or just not passing common sense).

Sure, if a catastrophe occurs, all bets are off, a 'portfolio' isn't going to be of any comfort. But if it doesn't, a 4% WR has a higher likelihood of failing before you do than a 3.5% WR, and a 3.3% WR, or a 3.0% WR, etc. There's no way around that.

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Old 07-05-2013, 09:07 PM   #67
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I just think they spend all their time coming up with parameters and models that will make things look even worse than their last paper!

Follow the money (the annuity industry).

Great discussion!

I'm sticking with my 3.33% withdrawal of remaining portfolio, and even plan to increase it if I get old enough.
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Old 07-05-2013, 09:25 PM   #68
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Agreed, I get tired of that being taken out of context (or just not passing common sense).

Sure, if a catastrophe occurs, all bets are off, a 'portfolio' isn't going to be of any comfort. But if it doesn't, a 4% WR has a higher likelihood of failing before you do than a 3.5% WR, and a 3.3% WR, or a 3.0% WR, etc. There's no way around that.

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Geez, I did NOT quote that article out of context, not in the least. I can't cut and paste the entire article into a discussion like this.

No one said that a 3.5% WR is not safer or more prudent than a 4% WR, etc. That is not what we are getting at.

The main point of the article is that it is NOT possible to have, for example, a 97% ex-ante financial success possibility, or even close. No matter how much money you have or planning that you do. Because matters other than investment returns take precedence at that point and saving more yields greatly diminishing returns against other higher outside probabilities that you cannot control.

And I do agree that one should be conservative like he mentioned if you expect lower returns in the future (something I agree with 100%, I don't use FIREcalc for projections because I think ex-ante returns are lower now). That is different than the main point of the article (but put there so people would not spend with wild abandon for the future) but an excellent point indeed.

Bernstein himself was recently quoted as saying the stock and bond markets are offering lower ex-ante returns now than anytime in history. THAT is something worth saving more for.
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Old 07-05-2013, 09:27 PM   #69
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Perhaps I screwed up something in my program, but, at least at first glance, there appear to be problems with both the model and the model calculations written up in the paper.

You should double check with the authors (and ask for their code). In my opinion, errors in papers (and code) are quite common (and reviewers never double check at that level of detail).


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One of the things that I find most suspicious about the paper is this. The found the optimum AA was 40% equities and 60% bonds. At time when bonds are at historic lows (when the paper was written) such an AA makes no sense even if you believe stocks are overpriced.
I think this could be plausible since the problem with equities is having to draw from your portfolio when there has been a bad sequence of returns.

BUT what makes me suspicious about their paper is that none of their forecast models have references and they don't talk much about how they set their parameters. They also make seemingly arbitrary adjustments (-2% for US), their inflation model has 5 parameters fit from maybe 100 data points, they have to arbitrarily cap PE10 at 5 and 45, and they don't do any sensitivity analysis or blind tests of their forecasts (on data held out from parameter estimation).
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Old 07-05-2013, 11:13 PM   #70
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Geez, I did NOT quote that article out of context, not in the least. I can't cut and paste the entire article into a discussion like this. ...
Sorry, I didn't mean to point that at you specifically.

Over the years, a number of posters have said something to the effect that anything past 80% in any calculator is meaningless, and I don't think that is what was intended, and I don't think it makes sense. My comment was more towards that past history.

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Old 07-06-2013, 12:12 AM   #71
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Sorry, I didn't mean to point that at you specifically.

Over the years, a number of posters have said something to the effect that anything past 80% in any calculator is meaningless, and I don't think that is what was intended, and I don't think it makes sense. My comment was more towards that past history.

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OK, thanks ERD50 Yes, I agree that 80% is too low and in my original post stated that Bernstein was just too negative in his calculations. But I think the underlying idea is sound and worth thinking about . . .
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Old 07-06-2013, 12:14 AM   #72
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You should double check with the authors (and ask for their code). In my opinion, errors in papers (and code) are quite common (and reviewers never double check at that level of detail).




I think this could be plausible since the problem with equities is having to draw from your portfolio when there has been a bad sequence of returns.

BUT what makes me suspicious about their paper is that none of their forecast models have references and they don't talk much about how they set their parameters. They also make seemingly arbitrary adjustments (-2% for US), their inflation model has 5 parameters fit from maybe 100 data points, they have to arbitrarily cap PE10 at 5 and 45, and they don't do any sensitivity analysis or blind tests of their forecasts (on data held out from parameter estimation).
Good points from all, especially the 2% adjustment. If I plug this in, I get a success rate of about 95%. And it's very hard to justify this adjustment, given that they use CAPE to predict stock returns, and the CAPE is apparently based on US stocks, while the adjustment is supposed to represent an international portfolio. Another problem is that the arbitrary PE10 5<->45 limits arbitrarily constrains the stock return to a range between about -14% to 20%. And the variance of the stock return distribution is much smaller than the S&P 500 variance.

I've convinced myself that the model has so many flaws that it isn't worth spending any more time on it (although independent verification would be welcome). And makes me desire a decent open source retirement calculator.
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Old 07-06-2013, 12:27 AM   #73
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And makes me desire a decent open source retirement calculator.
I've long thought this should be something a group of us should try for. It's not that hard, and there are surely enough people here who have the skills.
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Old 07-06-2013, 12:56 AM   #74
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I think this could be plausible since the problem with equities is having to draw from your portfolio when there has been a bad sequence of returns.

BUT what makes me suspicious about their paper is that none of their forecast models have references and they don't talk much about how they set their parameters. They also make seemingly arbitrary adjustments (-2% for US), their inflation model has 5 parameters fit from maybe 100 data points, they have to arbitrarily cap PE10 at 5 and 45, and they don't do any sensitivity analysis or blind tests of their forecasts (on data held out from parameter estimation).
Yes it is certainly true that if you have a bad sequences at the beginning a heavy equity concentration makes retirement challenging. But I haven't seen a FIRECalc run or any other research that shows that anything under 60% equities is optimum. On the other hand if you restrict equity returns to below historically levels then this make sense. I'm just saying that logically if bond yields are historically low it make sense to hold less bonds not more to have the maximum SWR.

All very good points.
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Old 07-06-2013, 07:05 AM   #75
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Your CDC chart may be misleading, because it blends sexes and races. Men clearly live shorter lives on average and being a single male I only have to worry about me. The obits I read every day show a trend, very few 90+ old men.
And the few 90+ men that you do see are usually still leaving a surviving wife behind. Widowers don't tend to live a long time once they are alone. They tend to either remarry or die fairly quickly (with some exceptions, obviously).
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Old 07-06-2013, 11:54 AM   #76
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.....Widowers ... tend to either remarry or die fairly quickly (with some exceptions, obviously).
Now that sounds like a really tough decision!
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Old 07-06-2013, 09:32 PM   #77
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Good points from all, especially the 2% adjustment. If I plug this in, I get a success rate of about 95%. And it's very hard to justify this adjustment, given that they use CAPE to predict stock returns, and the CAPE is apparently based on US stocks, while the adjustment is supposed to represent an international portfolio. Another problem is that the arbitrary PE10 5<->45 limits arbitrarily constrains the stock return to a range between about -14% to 20%. And the variance of the stock return distribution is much smaller than the S&P 500 variance.

I've convinced myself that the model has so many flaws that it isn't worth spending any more time on it (although independent verification would be welcome). And makes me desire a decent open source retirement calculator.
Many thanks, Fred and Photoguy. This confirms my suspicion, yet again, that these guys are determined to create whatever model will give the most depressing result yet not appear obviously flawed on the surface.
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Old 07-06-2013, 10:26 PM   #78
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Many thanks, Fred and Photoguy. This confirms my suspicion, yet again, that these guys are determined to create whatever model will give the most depressing result yet not appear obviously flawed on the surface.
I've been reading Pfau for a while now and he seems like a straight shooter. Many other pros look at his work and make critiques of it , e.g., Micheal Kitces, but they all seem to respect him and his methodology.

Fred, it's worth visiting his blog and posting your thoughts there, or just email him. He has a lot of influence so I, for one, would love to see what would come of your findings. Plus I'm sure you would also like to see for yourself who really is correct here.

Here's a link to his blog post about this article. I think it would be great if you would post your objections there

http://wpfau.blogspot.com/2013/06/as...portfolio.html

Brian
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Old 07-07-2013, 12:05 AM   #79
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I've been reading Pfau for a while now and he seems like a straight shooter. Many other pros look at his work and make critiques of it , e.g., Micheal Kitces, but they all seem to respect him and his methodology.

Fred, it's worth visiting his blog and posting your thoughts there, or just email him. He has a lot of influence so I, for one, would love to see what would come of your findings. Plus I'm sure you would also like to see for yourself who really is correct here.

Here's a link to his blog post about this article. I think it would be great if you would post your objections there

Retirement Researcher Blog: Asset Valuations and Safe Portfolio Withdrawal Rates

Brian
OK, let me think about how much I want to get involved in this before contacting him.Before I semi-early retired, I used to work in an academically oriented government lab, so this might end up being uncomfortably close to working again. Something along the lines of the old joke: "the reason academic politics are so bitter is that so little is at stake."
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Old 07-07-2013, 08:22 AM   #80
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Something along the lines of the old joke: "the reason academic politics are so bitter is that so little is at stake."
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