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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-24-2004, 10:14 AM   #21
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

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And then, And then - there is throw out all the data and live on what you make - i.e. the portfolio yield.
Thats essentially what i'm doing right now. Even with yields at an all time low, i should still pull enough dividend yield to make ends meet, and the instruments i'm using have historically done much better.

I've got a nice cash buffer set up, but the spend rate is the yield, period. In a lean year like this one, I enjoy my current style of living which isnt too bad. When the fatter years come along, I'll buy more toys, replace cars that are getting old (right now they're almost new), etc.
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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-24-2004, 10:20 AM   #22
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

Well now here's another thought. Could firecalc also spit out "best and worst" 3, 5, and 10 year periods for a particular asset mix and postulate on the relative drop of a portfolio and likelihood of a portfolio rebuilding period that allows maintenance of a SWR.
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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-24-2004, 12:32 PM   #23
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

Dory's analogy about umbrella's and rain buckets to explain the difference between SWR and average terminal value simulation made me think a little (and that's a good thing). But after some thought I'm convinced the argument doesn't hold water. Sorry, I just had to find a way to put that stupid pun in this post.

I think that the SWR simulation is more like this: You have 100 buckets and five hills. You can put as many buckets as you want on the "equity hill" and the remainder on one of the other hills -- TIPS hill, commercial paper hill, 5yr Treasury hill and 30yr Treasury Hill. Each bucket has some water in it that is being siphoned off by spending and evaporated by inflation. The goal of the SWR simulation is to find which hills to place the buckets on to keep from running out of water.

The only difference between the basic SWR simulation and the SWR simulation while observing terminal value is that you want to do more than avoid running out of water. You want to avoid running out of water while maximizing the amount of water you catch. Since the whole thing is historically based, neither may be valid. But I don't really see why one might be more valid than the other.

For this example the calculator runs strings of 30 yr histories and creates a distribution of over 100 results. The distribution of final terminal portfolio values can roughly be described in terms of a median value and a standard deviation. The average terminal value is near the middle of the distribution and the SWR represents one end of the distribution. So if you question the validity of one part of the distribution, you are questioning the validity of the other. If you believe the simulation predicts SWR but not average terminal value, then you must believe that the mean of future returns will decrease but the standard deviation will decrease to exactly compensate for it (or the other way around).

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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-24-2004, 01:49 PM   #24
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

"The Great Depression and the 70's stagflation were the results of bad monetary policy. We've learned our lessons, and it's unlikely we'll make mistakes like these again. Throw out the singularities and see how you do."

"Yep - that's why many shoot for 90% or 95% safe rates, instead of 100%."

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This assumes there are only two ways to screw up. There are probably hundreds. We just haven't seen them yet.
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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-24-2004, 02:16 PM   #25
 
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

There are hundreds. Maybe thousands.

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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-24-2004, 03:33 PM   #26
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

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Dory's analogy about umbrella's and rain buckets to explain the difference between SWR and average terminal value simulation made me think a little (and that's a good thing). But after some thought I'm convinced the argument doesn't hold water. * Sorry, I just had to find a way to put that stupid pun in this post.
Well, it doesn't seem quite right to me, but I may be all wet.

All in all, the research on asset allocation and the "efficient frontier" pretty much addresses all this stuff, doesn't it?

Here's the graph from the REHP:



When Intercst published this about 4 years ago, many of us ran to our SWR calculators and found that these allocation mixes were, in fact, the best over the historical periods we have been looking at.

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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-25-2004, 12:42 PM   #27
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

Lets hope the research is valid because the the curve fits my ballpark for 60-70% stock(counting my 'hobby' stocks) and 25 yr. span (my old 84.3 IRS no.).

Now - being the eternal putzer, I'm sitting here reading the Vanguard target retirement series wherein the asset mix slides/changes over time finally landing at 75% fixed (including 25/% inflation indexed) for when your really old say your 70"s. Fidelity and and T. Rowe Price have similar offerings.

I assume they read the same research we do so I wonder what "assumptions" they are using for their 'customers'. It looks like lowering std dev (risk?) as you age is a prime driver with the ability to consume principle - spend down to your last dollar as side benefit.

?? How do you compare the two??
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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-25-2004, 03:12 PM   #28
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

Gee Dory - I guess we just get wrapped up in the discussion and forget what has been done. I looked back at the REHP site and found this:


Which looks a lot like SG's graph. I still wonder how the shape of the curve changes when moving to 40 and 50 year plans.

Unclemick - In regard to packaged retirement target funds. I suspect that they want to target investors who have heard the conventional folklore that bonds are for retirees, so they have to weight it on that side. Remember it is still a mutual fund and makes the producers money only if people invest in it!

Also, I wonder what happens if we run calculations with the future variations set to either 50% or 150% of history....maybe they have different assumptions?

Now, back to the asset allocation question. I think my earlier comments were a little muddled - I'm not a good riter! The SWR studies have determined the optimal asset mixes to maximize the current SWR. There is mention of different mixes providing higher terminal values, but little detail on the advantage of them beyond "future higher withdrawals". I stated some calculated numbers above, but have not run enough tests to plot a graph, on one possible additional measure that could be easier to understand. I called it the "5 year SWR" and just put the data inline. The 5 year SWR was defined as the SWR supported by the average portfolio after 5 years. Here it is in more of a table:

Some data for a 1mil portfolio in equity and tips@2.5 for a 30 year plan:

mix initial SWR 5yr SWR
75% equity, 25% tips $46700 $60782
25% equity, 75% tips $46400 $54853

This is an attempt to quantify the upside of different asset allocations from a SWR point of view. A 10 year SWR point could also be added. After taxes are done, I think I will try to calculate more data points and graph them.

In any case, the earlier question was about asset allocation and SWR. I think SWR provides one input to an asset allocation decision, and potential upside provides another. Your own preferences on the value of that upside, personal preferences for or against tips, bonds, etc. are also factors. It isn't as simple as picking the optimal SWR.

Wayne
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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-25-2004, 03:42 PM   #29
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

I was also looking at old REHP articles. I didn't find Dory's chart, but it seems to be related to this study on survivability over different payout periods:

http://www.retireearlyhomepage.com/assetal.html
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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-26-2004, 03:13 AM   #30
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

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I was also looking at old REHP articles. *I didn't find Dory's chart, but it seems to be related to this study on survivability over different payout periods:

http://www.retireearlyhomepage.com/assetal.html
It's at http://www.retireearlyhomepage.com/restud1.html
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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-26-2004, 07:45 AM   #31
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

The "efficient frontier" graph posted by WZD on Jan 25 makes a lot of sense conceptually, in that it indicates that TIPs will support a substantially higher SWR than commercial paper as the "fixed income" component of a portfolio. *However, two things bother me about it. *First, I'm not sure what interest rate was used for the TIPs. *

More importantly, however, I assume that the rate of return used for the stock portion was the actual historical rate of return, which amounts to a real return of about 7.5% per year. *I think that the intelligent way to view historical data is to understand not only what happened, but why. *Future projections should not be "blind" projections of past trends, but rather should consider the "why" and try to anticipate what conditions are likely to be different in the future, and how this will be likely to cause future trends to vary from historical ones. *For various reasons, I think that it is both logical and prudent to estimate that the future real rate of return on stocks will be about 2% below the historical trend.

This has important implications for asset allocation, in that it makes TIPs relatively more attractive and substantially increases the theoretically optimal allocation of TIPs relative to stocks.

To generate my own version of the "efficient frontier," I ran FIRECalc with inputs modified to (I think) reduce the average return on stocks while maintaining a return on TIPs of 2.25% (plus inflation). *I did this by assuming that annual expenses for the portfolio would actually be 0.25%, but I entered 2.25% to artificially reduce the portfolio return by 2%. *But then, I set the return on TIPs to 4.5%. *(I used a 30 year period and the CPI for inflation adjustment.) *Here are the rather surprising results:

STOCK % * * * * *95% SWR * * * * *100%SWR

80 * * * * * * * * * * * * * 3.76% * * * * * * *3.32%

60 * * * * * * * * * * * * * 4.05% * * * * * * *3.64% * * * * * * * * *

40 * * * * * * * * * * * * * 4.23% * * * * * * *3.92%

30 * * * * * * * * * * * * * 4.29% * * * * * * *4.05% * * * *

25 * * * * * * * * * * * * * 4.31% * * * * * * *4.12%

20 * * * * * * * * * * * * * 4.33% * * * * * * *4.18%

15 * * * * * * * * * * * * * 4.35% * * * * * * * 4.22%

10 * * * * * * * * * * * * * 4.36% * * * * * * * 4.10% * * *


So for those of you who have a fear of stocks, this provides rather good rationale for avoiding them. *A word of caution, however, is that the FIRECalc program may be using my inputs differently than I think.
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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-26-2004, 10:02 AM   #32
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

Excellent information, Ted, Wayne, SG, and others! My stock allocation is on the low end compared to many here (although not as low as John's ). This data reinforces what I'm intending to do. I'm still waiting for TIPS to bounce back to around 2.5%.
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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-26-2004, 10:37 AM   #33
 
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

Ted,

Yes, your numbers are very surprising!! *- Maybe Dory can confirm the accuracy of these figures.

Got me thinking about running FIRECalc with 100% TIPS! *- I found out I don't need to be in Stocks at all and can actually increase my Standard of Living! - I am going to have to think about this seriously for a few days and then join the investment club of John Galt!
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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-26-2004, 11:28 AM   #34
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

Ted -

When I read through those articles on the REHP a few months back, if my memory serves the TIPS yields used were quite a bit higher than they are today...3.4 or 3.5%?
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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-26-2004, 11:32 AM   #35
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

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I think that the intelligent way to view historical data is to understand not only what happened, but why. Future projections should not be "blind" projections of past trends, but rather should consider the "why" and try to anticipate what conditions are likely to be different in the future, and how this will be likely to cause future trends to vary from historical ones. For various reasons, I think that it is both logical and prudent to estimate that the future real rate of return on stocks will be about 2% below the historical trend.
Ha...yesterday I actually wrote a reply to this thread saying essentially the same thing...that some elements be introduced into firecalc to not only tell you when a set of circumstances would fail % wise, but to add some thinking to the periods that it failed in and the likelihood of them appearing during the draw period.

After I got done writing it and re-read it, I figured it was pointless because future predicting is no more plausible than the likelihood of calculating future returns on past data and I deleted it.

Anyhow, the point I was going to make is that in all of the cases where my results were below 100%, the percentage wasnt really the thing, it was the conditions during the years of failure. Always that 1965/66 start period. Stock market dumped, did lousy for an extended period of time, and raucous inflation. Not entirely unlike what a lot of folks here and elsewhere think we might face in the near future.

The main point is, unless your porfolio can survive such an event, 97% success rate doesnt mean much. I've looked extensively and cant find a mix at my withdrawal rate that survives that two year start period, no matter what asset allocation used. So unless you're starting with a BIG bucket, you better plan on changing asset allocations if and when such an event occurs, then switch back when its over. IF you can figure out its happening...
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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-26-2004, 11:38 AM   #36
 
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

Can any of you geniuses tell me why with 100% TIPS an expense ratio of .22%, return of 2% that you get 93% SWR?

I thought that if you got a 2% TIPS and 0% in stocks you'd either be 100% safe or 100% fail

There must be something about this that I don't understand.

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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-26-2004, 11:42 AM   #37
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

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A word of caution, however, is that the FIRECalc program may be using my inputs differently than I think.
Unless i'm mistaken, the results of this wont exactly be what you intended. Mostly to do with -when- the management fees are deducted rather than the rationale.

I think what you intended was to produce a rate of return lower than the program intends (how about a field in the program to enter a rate of return adjustment?) by a percentage, but view this simple calc. None of these number mean anything except as an example:

I have $100. Program adds a 9% return and produces $109. A minus 2% management fee intended to reduce me to 7% rate of return takes me to 106.82. If instead I have $100 and add a 7% increase, I get 107.

So unless I should have waited for coffee to do this, your calculations are producing result numbers slightly lower than intended.

This assumes the program applies annual gain rates to the capital, then reduces the capital by the management fee percentage. If it does it the other way around, I think that would be an incorrect way of doing it and would produce different numbers from reality.
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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-26-2004, 12:02 PM   #38
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

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Can any of you geniuses tell me why with 100% TIPS an expense ratio of .22%, return of 2% that you get 93% SWR?

I thought that if you got a 2% TIPS and 0% in stocks you'd either be 100% safe or 100% fail

There must be something about this that I don't understand.

Cut-Throat - The willing to be enlightened.
I'm going to guess. During periods of inflation TIPS bond values are increased as a taxable event annually. During periods of deflation, the values are decreased...although for the life of me i'm not sure how that would be handled in tax-land...does it count as a loss?!? Since we had some periods of deflation, that may have caused a loss of the bond value to the extent where the returns thrown off were overcome by your withdrawal rate.

Which leads me to ask if Firecalc reduces the withdrawal rate during periods of historic deflation?
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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-26-2004, 12:07 PM   #39
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

Heres another interesting question...how come every time I go use firecalc I get logged out of the main forum and have to log back in again?
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Re: SWR, terminal values, TIPS, I-bnds & comm pape
Old 01-26-2004, 12:12 PM   #40
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Re: SWR, terminal values, TIPS, I-bnds & comm pape

One limitation on TIPs that probably is not picked up by FIRECalc is that there is some volatility in their total return as the result of short-term market fluctuations, that is probably not picked up by FIRECalc. My guess is that FIRECalc assumes that the return from TIPs during any particular year would have been the interest yield plus whatever inflation occurred that year. This will work out to be correct over the life of any TIP issue, but there will be some annual deviations. During the past few years, the interest yield on TIPs has dropped and as a result the market value on TIPs that still are long-term has increased by more more than the inflation adjustment. The reverse will happen if the interest yield on TIPs goes back up. So if I wanted to depend heavily on TIPs in my retirement portfolio, I would still keep at least 25% of it in stocks (unless the planning period was less than 30 years). In fact, I have a lot more than that in stocks now, but am convincing myself of the wisdom of selling a substantial portion of them when the indicators start looking less favorable.
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