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

[Ted]

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

I agree that this "rule of thumb" provides a useful "reasonability check." But there are various individual circumstances that may justify deviating from it. One of the values of this forum is to discuss those circumstances.

In response to SG.... As I said in my previous post, I think that the best way to address the problem of being overly conservative (in running FIRECalc with the historical returns on stocks artificially reduced) is to select a SWR that gives something on the order of an 80% success rate over a conservatively long withdrawal period. In doing that, a person is excluding the historical periods that experienced the most severe downturns of the stock market.

Sure, there were 10-year periods when stock market returns were below the historical average, but (not surprisingly) these were part of longer periods when the returns during other years in the period were substantially higher than the average. That's what produces an average! What Bogle and I are saying is that we think the average (real) rate of return in the future will be less. Taken at face value, this would imply that the positive returns during expansions will be less positive, and that the negative returns during contractions will be more negative. Because of substantially improved government financial policies, I don't think that periods of negative return will be more negative than in the past, and that is why I would feel comfortable with an SWR at the 80% level.

The ideal thing to do is to look at the issue several ways, as Cut-Throat did, and settle on a solution that is reasonably consistent with all of them. At any rate, what an individual does is their own business. That's what makes a market.

[wzd]

SG -

Looked over on the MSN board. The results are interesting in that the curve flattens, and shifts a little toward higher equities, but not as much as I would have expected.

Thanks! I can't use excel for another month at least. It seems that loading the spreadsheets messes up some default settings my wife uses, and she is in the middle of girl scout cookie sales. Since she runs it for the area, and deals with thousands of cases, we don't want that job to get any harder.

Wayne

[sgeeeee]

.... As I said in my previous post, I think that the best way to address the problem of being overly conservative (in running FIRECalc with the historical returns on stocks artificially reduced) is to select a SWR that gives something on the order of an 80% success rate over a conservatively long withdrawal period. *In doing that, a person is excluding the historical periods that experienced the most severe downturns of the stock market.

*Yes, I see the logic in reducing your success target in order to accomodate your assumptions. Do you have any suggestions on how much to reduce your SWR target for each percent you reduce the market return? Why 80%?

Sure, there were 10-year periods when stock market returns were below the historical average, but (not surprisingly) these were part of longer periods when the returns during other years in the period were substantially higher than the average. *That's what produces an average! *What Bogle and I are saying is that we think the average (real) rate of return in the future will be less.

I didn't get the impression from the Bogle article that he was saying that the average real rate of return would be less than average for more than the next 10 years. I only saw his predictions for the next 10 years. That's why I believe he broke the last century down into decade long periods -- so he could make a direct comparison to his predictions. I guess I am suspicious of any predictions that would be longer term than that. A lot can happen in 10 years.

But a look at the Bogle data for the past century indicates that there were many 30 year periods that produced market returns that were well below the average (ave=10.4%). Here's what I calculate from his charts:

YEARS Average Annual
Market Return
1900-1929 8.79%
1910-1939 5.43%
1920-1949 7.34%
1930-1959 8.97%
1940-1969 11.96%
1950-1979 11.02%
1960-1989 10.15%
1970-1999 13.53%

So even if you believe that Bogle's lower limit estimate of 6% for the next 10 years may be applied for the next 30 years, FIRECALC is already including a case from 1910-1939 that is worse than that.

If you restrict your modified FIRECALC simulations to the period of time between 1930 and today, you might get a good indication of how to best allocate in an environment of reduced market returns using TIPS.

Just some thoughts.

The ideal thing to do is to look at the issue several ways, as Cut-Throat did, and settle on a solution that is reasonably consistent with all of them. *At any rate, what an individual does is their own business. *That's what makes a market.

I'm all for looking at things in different ways. And I agree not to invest anyone else's money if they don't invest mine.

[Ted]

Yes, I see the logic in reducing your success target in order to accomodate your assumptions. Do you have any suggestions on how much to reduce your SWR target for each percent you reduce the market return? Why 80%?

I didn't get the impression from the Bogle article that he was saying that the average real rate of return would be less than average for more than the next 10 years. *I only saw his predictions for the next 10 years. *

But a look at the Bogle data for the past century indicates that there were many 30 year periods that produced market returns that were well below the average (ave=10.4%).

So even if you believe that Bogle's lower limit estimate of 6% for the next 10 years may be applied for the next 30 years, FIRECALC is already including a case from 1910-1939 that is worse than that. *

In his article, Bogle chose "decades" as the periods over which to analyze market returns. Although his projections (as of June 2003) were limited to the next 10 years, any retired person who expects to withdraw money from their assets for longer than 10 years is making certain assumptions about future market conditions, whether or not they do so consciously. For my part, I think that it is both prudent from a personal financial planning standpoint, and logical for reasons of fundamental economics, to assume that the reduced stock market returns predicted by Bogle will continue indefinitely past the next 10 years.

In other words, this rate of return is what I consider to be the EXPECTED (average) rate of return in the future. This implies that the actual returns during roughly half of future periods (of whatever length) will be less than this. To simulate the possible impacts of this on a person's SWR, I don't feel comfortable using historical data AS IS from a period of history when the average rate of return on stocks was about 10.5%, even though it includes some periods when the return dropped below this.

The one way in which I feel that Bogle's paper could be improved would be for him to evaluate market returns on a real return basis, which would factor out the varying effects of inflation. If this were done, I guess that his projection of a 6% to 9% return on stocks over the next decade would translate into a projected real return of 4% to 5%, which is pretty modest in comparison to the historical average real return of about 7.5%.

Looking at historical 10 year periods, the average real return on stocks was this 7.5%, and the standard deviation was about 3.5%. From the standpoint of a person drawing down assets, a high average real return is good, and a high standard deviation is bad. Even though I am pessimistically predicting that the real rate of return in the future will drop to about 5.5%, my one optimistic assumption is that market returns will be less volatile, causing the standard deviation to be less. The way that I feel most comfortable modeling this with FIRECalc is to adjust the historical data to mathematically reduce the real return on stocks by 2%. Since I can't make a similar adjustment to reduce the standard deviation of the returns, I accept a lower "success rate" of around 80%. This has the effect of disregarding roughly the 20% of the periods (such as the 1930s) when the departure of market returns below the average was greatest. Admittedly, this selection of this "success rate" is somewhat arbitrary, but for that matter, so is the selection of a success rate of 95%, 100%, or whatever, based on a historical pattern of returns that is unlikely to be repeated.

What I have found to be interesting in running FIRECalc with various scenarios that I consider to be "reasonably conservative," is that for planning periods over 20 years, and for mixtures of stocks and TIPs (with about a 2% interest yield) ranging from 10% stocks to 80% stocks, the SWR works out to be very close to 4% per year. This will happen if a person runs FIRECalc "as is" and uses a "100% success rate."

Having a higher percentage of stocks drops the SWR slightly, and increases the "expected" terminal portfolio value substantially.

[Michael]

Ted wrote:

"my one optimistic assumption is that market returns will be less volatile"

Mike asks:

Why do you think the market will be less volatile Ted?

[haha]

Here is what Robert Aliber of the Univerersity of Chicago thinks about returns and volatility of stocks vs. TIPs going forward:

Stockholders are clearly in danger. "More than 3000 firms are listed on the NASDAQ. Our data set includes the 489 largest firms; their combined market value was $2,200 billion and their forward earnings are about $50 billion for a price earnings ratio of 45. Five firms - Microsoft, Intel, Cisco, Dell and AmGen - account for nearly 50% of the earnings and one-third of the market cap. The price-earnings ratio for the remaining firms is 56. Many of the firms listed on NASDAQ (AMEX:QQQ - News) have grand prospects - if we only knew which ones. Still there is no way that the earnings of NASDAQ firms as a group can increase so that the rates of return to the owners of stocks of this group will be higher than the rates of return from buying a US Treasury price level indexed bond. At some stage the air in the NASDAQ bubble will leak out. The likelihood that the prices of stocks traded on the New York Exchange (AMEX:SPY - News) will not be affected is low."

Your humble correspondent concurs.


Mikey

[cute fuzzy bunny]

When was this written and do you have a source for the complete document?

[Ted]

Why do you think the market will be less volatile Ted?

Because the body of knowledge about macroeconomic policy has expanded greatly, and all of the presidents who have been elected since and including Jimmy Carter have been smart enough to appoint Federal Reserve chairmen (Paul Volcker and Alan Greenspan) who understood how to apply it to smooth out the extremes of the business cycle. *

My optimism presupposes that a relative extremist like Howard Dean (who has said that he would fire Greenspan) won't be elected president. *Even under that scenario, there are certain economic stabilizers that have now been institutionalized that would tend to prevent a repeat of the 1930s.

[haha]

When was this written and do you have a source for the complete document?

http://biz.yahoo.com/ifunds/040129/2..._etf_st_1.html

[Michael]

Thank you Ted. I would agree that the Fed is more experienced now then it was in 1929. Although the recent Japanese experience makes me think that modern economics has not yet solved all of the problems. It is a learning process.

[Ted]

The problem with Japan -- and in many other countries -- is the lack of political will to undergo short-term "pain" to make the economic adjustments that are necessary for long-term "gain." Generally, these adjustments initially produce unemployment and associated lower wages -- which no populist politician is ever willing to accept. So, politically, there is an eternal competition between people who are more-or-less living hand to mouth and have a short term perspective, and those who have some financial security and can afford to take a longer term perspective. Fortunately, the latter have generally predominated in the U.S. since World War II, and the U.S. has the world's highest standard of living as the result.

[Michael]

Japan does have less political will with respect to unemployment. It also has an older baby boom than we do, which has already moved into the age where people traditionally spend less. Perhaps our leaders' policies will moderate the effect of our own baby boom's retirement in a few years to a greater degree than in Japan. It may all hinge on who is in power at the time, which is hard to predict. We will soon know.

[Ted]

The chief measure that will be required to "moderate the effect of our own baby boom's retirement" will be to induce people to keep working longer. The realities of economics will do this whether government policies assist in the process or not.

As I have said before, people's goal of early retirement is directly contradictory to this national economic reality. The best compromise is for people to cut back to part-time work, but continue performing it beyond "standard" retirement age. Having done this myself, I don't think that it is any sort of "unfair burden." But in any case it is the only way to resolve the conflict that will develop between future retirees and future workers, who will be subjected to an substantially increasing tax burden to support us retirees.

[wabmester]

people's goal of early retirement is directly contradictory to this national economic reality.

We got out while the getting was good. I bet that our generation of ERers will be the last for a while. We just lived through an amazing 20-year bull market and witnessed the beginning of the end of corporate pensions and social security benefits at the tender young age of 65. ER starts and ends with us.

[haha]

We got out while the getting was good.

While I agree with you that we benefited from an insane boom, to my mind we can't exactly cash out of the economy the way one can cash out of a poker game after a strong win (well, sometimes he can!). So I don't think we are really in the the high cotton. Many things could happen to seriously impact how things go for us. In stead of lucky early birds, we could look simply deluded. This isn't really my opinion on it, but it does seem to be a possibility.

One thing for sure, we should fight like hell to hang on to the government backed, COLA monthly income given by social security. I just wish I had been more of a worker bee, so I could look forward to a bigger SS stipend.

Mikey

[cute fuzzy bunny]

Eh, it could all turn bad and we'll all go back to work, but I've already had 3 years "off" and figure every day from here is gravy. I wouldnt freak out if I had to go back but I'd rather not.

By the way, some of my fondest memories are not of being a good worker bee, but generally involve some smartassedness

[Bob_Smith]

One thing for sure, we should fight like hell to hang on to the government backed, COLA monthly income given by social security.

I agree Mikey.

[wabmester]

I wouldnt freak out if I had to go back but I'd rather not.

Argh. Not my worst nightmare, but a pretty bad dream for sure. I met a few early retirees who de-retired during the recent bear market. It was just sad.

I'd expect most people to have a feeling of schadenfreude if I de-retired, but I think everybody has a deep sense of what it'd be like to go from slavery to freedom and back to slavery again. Ugh. Even though I liked what I did for a living and liked the people I worked with, it'd be tough to go back to the daily grind.

I guess going back to work has to be one of my worst
nightmares. Of course, I've been ERed a long time.
I still have plenty of business ideas, just no energy or motivation. Anyway, I mostly enjoyed big chunks of
all phases of my 6 decades on the planet. I enjoyed working and then I enjoyed not working. I enjoyed being married and I enjoyed being single. Not school though.
I never did get to liking that.

John Galt