SWR, terminal values, TIPS, I-bnds & comm paper

Hello Ted. Re. "unless the planning period was less than 30 years", as regulars know my planning period is
quite short. As far as "active planning" (investment
and other) I would seldom look out further than, say
5 years max. Now, the interesting part is that if I
was 40 instead of 60 (and knew what I know now)
my planning period wouldn't change much. I think it is
foolish to rely on what you hope to be doing in 10-20-30
years, for any purpose. Know how you will live if you make it, but
don't count on it.

John Galt

TH,

Yup, you are probably right when you included taxes in high inflation periods. Which brings up another question. Does FIRECalc assume that all funds are held in taxable accounts? *- It never ends does it ?

I also have had to Login each time I run FIRECalc. Firecalc probably destroys your cookies is my guess.

Anyway, If our nest egg in 8 years looks OK, I will be joining the John Galt school of investing. 100% in TIPS and 0% stocks.

[cute fuzzy bunny]

Firecalc probably destroys your cookies is my guess.

That sounds extremely painful

Funny it should do that. It doesnt seem to store any of your inputs to carry forward to future runs.

Odd.

Comment on taxes is sound. There are no provisions for taxable and nontaxable accounts, and an estimator that would identify approximate tax implications (at least at the federal level) and raise the withdrawal rate to include those would be helpful. Although I s'pose you could simply figure your own tax burden and roll that in yourself. I add 6k (~25%) to my withdrawal rates even though I shouldnt have to pay any taxes for at least another 3-5 years.

[wabmester]

Wow, I never thought I'd see this. A mass epiphany that historical stock returns aren't guaranteed in the future and that an instrument with guaranteed real returns will give you a more predictable income!

But I have to admit, the risk mitigation voodoo of MPT is more entertaining to read.

Wow, I never thought I'd see this. *A mass epiphany that historical stock returns aren't guaranteed in the future and that an instrument with guaranteed real returns will give you a more predictable income! *

But I have to admit, the risk mitigation voodoo of MPT is more entertaining to read.

Well, it all depends on the size of your portfoilo. If I had $10 Million, I would not even think about stocks. If I only had $250K - they would be mandatory! -

I don't think any one on this forum ever said that historical stock returns were guaranteed in the future. But, if I had to guess - I'd say that the Stock market will be higher 20 years from now than it is today! Wanna place a side bet!

Well Cut-Throat, for the sake of debate I could take the exact opposite
position. With 10 million you could afford to gamble on stocks, but with only $250,000 you could not afford to take a chance. For example, with a paid off house and SS coming in, plus let's say only 5% on your $250,000, a couple
could squeak by. Now, if inflation takes off, then you
might have a problem.

John Galt

[sgeeeee]

Before you liquidate your entire equity holdings, you might want to consider some of the following.

1) Although I have heard reasonable arguments from respectable people that equity returns might be lower than the historical average over the next 5 to 10 years, I haven't heard any credible arguments that equity returns will lag historical averages for the next 3 or 4 decades. That's how long my portfolio probably needs to survive. Such an argument is basically saying that "this time things are different". I'm skeptical of these kinds of arguments.

2) Although FIRECALC simulations that increase TIPS rates and expence ratio will result in an effective reduction in average equity returns and give TIPS an advantage, it is accomplished by reducing all equity periods. So you make the Greate Depression and all major market crashes worse than they really were in the simulation. But if equity returns of the near future are really below the historical averages, that might be accomplished by clipping the peak earning periods significantly rather than by sinking the the entire curve. I don't know how to use FIRECALC to simulate that effect, but I believe that it would have a remarkable effect on SWR and stock allocation as compared to the overall reduction approach.

3) I started this thread trying to draw attention to the importance of considering average terminal value as well as SWR. Although I mentioned how increased average terminal value could lead to increase withdrawal rates in the future, such increases also have a very important positive effect on portfolio longevity risk. Unless you know exactly when you are going to die, this should be important to you.

Using the optimum 100% safe case from Ted's simulation:
30 year
4.22% maximum safe withdrawal rate
15% stock
TIPS @ 4.5%
expense ratio = 2.25%
CPI inflation metric

This 100% safe situation results in a terminal value of 76% of the initial nest egg.

Keep all the numbers identical but increase the period to 35 years and the survival rate drops to 75.8%.

It is difficult to make a direct comparison to a more stock rich portfolio but here is an example that shows the importance of adding to the stock allocation and increasing average terminal value.

30 year
3.64% maximum safe withdrawal rate
60% stock
TIPS @ 4.5%
expense ratio = 2.25%
CPI inflation metric

This 100% safe situation results in an average terminal value of 233% of the initial nest egg.

Keep all the numbers identical but increase the period to 35 years and the survival rate shrinks slightly to 98.5%.

Clearly, the retiree looking at these two cases would need to save ~16% more money to keep initial withdrawal rate constant and move to a 60% equity position, but the fear of living five or more years flat broke would be reduced.

[wabmester]

I haven't heard any credible arguments that equity returns will lag historical averages for the next 3 or 4 decades.

This is basically what it comes down to, isn't it? * We know that stocks will be volatile, but we can only hope that history will be a guide to returns.

There are several things that bother me about using history as a guide:

1) The mysterious increase in P/E ratios over the last 20 years or so. *In theory, P/E should be a predictor of dividend yields or earnings growth, but I believe it's been consistently high by something like 3% in recent history. * Hopefully Ted can set me straight on this and how it jibes with efficient markets. *In any case, watch out for a long-term reversion to the mean!

2) I suspect that the number of retail investors is at an all time high, although I don't actually know the numbers. *This can only lead to increased volatility.

3) I think we must be getting to the point of diminishing returns from an economic historical perspective, don't you? *I mean I can imagine some crazy nanotech, holographic, neural implant future, but I just don't see a repeat of the productivity gains of the last century.

Edited to add this link provided today by our hero Larry Swedroe:

http://papers.ssrn.com/sol3/delivery...tractid=476981

Although the probable rewards from equity investment are attractive, stocks did not and cannot offer a guaranteed superior performance over the investment horizon of most investors. Furthermore, their prospective returns are lower than many investors project, whereas their risk is higher than many investors appreciate. Investors who assume that favorable equity returns can be relied on in the long term or that stocks are safe so long as they are held for 20 years are optimists. Their optimism is irrational.

[TheFIREman]

It is poor argument indeed to use immature and relatively illiquid equity markets as an example of what can happen in a mature market like the US. The only point that I agree with Swedroe on is that the sample size is too small. Failing a collapse in capitalistic society, I do not see a better investment than the enterprise of individuals (in the long run, and PLEASE don't quote Keynes).

[Ted]

Before you liquidate your entire equity holdings, you might want to consider some of the following.

1) I haven't heard any credible arguments that equity returns will lag historical averages for the next 3 or 4 decades. *
2) Although FIRECALC simulations that increase TIPS rates and expence ratio will result in an effective reduction in average equity returns and give TIPS an advantage, it is accomplished by reducing all equity periods. *So you make the Greate Depression and all major market crashes worse than they really were in the simulation. *But if equity returns of the near future are really below the historical averages, that might be accomplished by clipping the peak earning periods significantly rather than by sinking the the entire curve. *I don't know how to use FIRECALC to simulate that effect, but I believe that it would have a remarkable effect on SWR and stock allocation as compared to the overall reduction approach.

3) I started this thread trying to draw attention to the importance of considering average terminal value as well as SWR. *Although I mentioned how increased average terminal value could lead to increase withdrawal rates in the future, such increases also have a very important positive effect on portfolio longevity risk. *Unless you know exactly when you are going to die, this should be important to you.

I partially agree with these comments, and that is why I recommended keeping a higher percentage of equities than the 10% that gave (by a small margin) the highest SWR in my example. Specifically,

1) Argument #1 is that about 1% of the historical annual return on equities has been attributable to an increasing risk premium (P/E ratio). This can't keep increasing indefinitely, and if it simply stabilized, the effect would be to reduce equity returns by 1%. John Bogle describes this in detail in this article on the "Bogle Center" at the Vanguard site: http://www.vanguard.com/bogle_site/sp20030605.html

In addition to that, I agree with the concerns mentioned by Wabmester in item 3 of his last post. On top of the possibility that there will be no technological breakthrough to drive economic growth, there are the negative factors of an increasing, economically dependent retired population, and an increasing scarcity of easily recoverable oil.

2) This is a good point. I am optimistic that, even though equity returns will be less, there won't be any extreme crashes of the type that occurred in the 1930s. The way to handle this, and the legitimate concern expressed by SG in his item 3, is to use a very conservatively long planning period, but to allow for a withdrawal rate that has a lower probability of success -- maybe something like 80%.

Two additional factors that reduce the chances of a person completely depleting their assets are (1) the probability that they will die first (and die rich...Yee-haa!)
and (2) that their inflation-adjusted expenses in their later years will be lower than initially.

[dory36]

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?

Doesn't and hasn't happened to me -- no idea why it should happen to anyone. I'll poke around.

What browser are you using?

Dory36

[Jarhead*]

Well Cut-Throat, for the sake of debate I could take the exact opposite
position. * With 10 million you could afford to gamble on stocks, but with only $250,000 you could not afford to take a chance. *For example, with a paid off house and SS coming in, *plus let's say only 5% on your $250,000, *a couple
could squeak by. *Now, if inflation takes off, then you
might have a problem.
Hi John:
Good point. (I think that Cutthoat figures he could still take all his elaborate trips without having to worry about the stock mkt. if he had $10,000,000.
I have read enough of your posts to understand that you have a very different mindset than Cutthroat.
Having gone through the entire inflation cycle with a young familiy, it to this day, effects my thinking on what a horrendous tole inflation takes on fixed income investing.
It is all a crapshoot, but one of the ways I have tried to hedge my bets, is to stay short on bonds, and use CDs
5 year ladders in case we return to that type of inflation.
During the last inflation period (mid 60s to early 80s, CD investors did ok. No loss of principal, and could pretty much stay at least even with inflation. (long term bond holders were punished).
I am sure i am not telling you anything you do not already know, just to let you know I personally agree with your take on the no stock position with a $250,000
portfolio, given your ability to live the way you want at a lower income requirement than Cutthroat.
I still have equities, but in a much lower percentage than I had a few months ago.
Regards, Jarhead









John Galt

[wzd]

Doesn't and hasn't happened to me -- no idea why it should happen to anyone. I'll poke around.

What browser are you using?

Dory36

Happens to me. I'm using netscape 7.01. I can close the yabb tab (I use tabbed browsing, and keep a lot of tabs open), and the username/pw cookie is still present. When I open a new tab and visit firecalc, the yabb username and password disappear, but the session cookies are still present.

extra note: Even if I leave the bb tab open, going to firecalc in a new tab clears the username/pw cookies.

Wayne

[cute fuzzy bunny]

Doesn't and hasn't happened to me -- no idea why it should happen to anyone. I'll poke around.

What browser are you using?

Dory36

Primarily mozilla firebird (tabbed browsing is amazing), but I just reproduced it with fully current IE on XP. What I did to repro under IE:

Went to the main page. Choose login. logged in. clicked on red 'try firecalc' link on main page. ran summary result with stock data. closed firecalc results pop-up window. clicked 'left arrow' to back up to main page. click on any forum link. header information shows 'login' instead of 'logout' to indicate i'm no longer logged in. reply to any post asks for user name.

looks like at least one other has had the same problem.

hope this helps.

[wzd]

yes, IE does it for me too. No need to do anymore than load the firecalc page, then go to the yabb site again. If you don't use the back button, but the address bar to select from history, the problem is evident immediately.

Wayne

[cute fuzzy bunny]

[homer] mmmmm...cookieeees... [/homer]

Ted,

I played a bit with FIRECalc today and discovered some interesting numbers also. Even if future returns are as good as the past, the Stock Allocation to Tips with the Greatest SWR at 100% would be 40% Stocks and TIPS at 2% interest! Better than 100% stocks.

I used a 35 span of portfolio life. I also factored in my SS as well as my wife's - This would be for 10 years out in the future.

This gives Credence to the Formula of taking 100 - age and that is the amount you should have invested in Stocks.

[sgeeeee]

Ted,

Thanks for the url for the Bogle article. I found it a very good read and will repeat the link here for others who may have missed it in your earlier post.

http://www.vanguard.com/bogle_site/sp20030605.html

Bogle predicts market return for the next 10 years to be in 6% to 9% range with a target value of 7.5%. That number is contrasted with the average decade return for the past century of 10.4%.

If you look at the returns for other decades over the past century, you will notice that returns were below Bogles target of 7.5% during three of those decades (1910's at 2.9%, 1930's at -0.8%, and 1970's at 5.9%). All three of these decades returned less than Bogle's lower limit prediction of 6%.

Three other decades produced returns within Bogle's 6% to 9% range (1900's at 9%, 1940's at 8.6% and 1960's at 7.6%).

So 6 out of 10 of the decades of the last century have produced market returns in the range of those predicted by Bogle for the next 10 years.

This makes me question the wisdom of modifying FIRECALC (through high expense ratio and TIPS interest) to artificially reduce market returns in computing the efficient frontier. Decades like the one being predicted by many wise analysts are already included in the FIRECALC history. Reducing returns further seems to me to be accounting for the same issue twice.


wzd,

The SWR6.1 plots with 40 year calculations are posted on the MSN board.

[wabmester]

And here's the Bernstein article referenced by Bogle:

http://www.firstquadrant.com/PDFs/02..._Is_Normal.pdf

So 6 out of 10 of the decades of the last century have produced market returns in the range of those predicted by Bogle for the next 10 years. *

This makes me question the wisdom of modifying FIRECALC (through high expense ratio and TIPS interest) to artificially reduce market returns in computing the efficient frontier. *Decades like the one being predicted by many wise analysts are already included in the FIRECALC history. *Reducing returns further seems to me to be accounting for the same issue twice.

Excellent point SG!,

Even though future returns for the next 20 years may be lower, they may not be lower than the decade of the 30's. But even if they were, you'd still survive if you took the SWR recommended by FIRECalc.

It seems like FIRECalc is probably the best planning tool that we have.

History probably does repeat itself! *That is why I bank on the Sun coming up every morning; becuase it did yesterday!