Wade Pfau looks at 4% WR, finds it unsafe

[audreyh1]

Audrey, I'm curious what you are then favoring? I promise not to critique your choices and if you prefer not to discuss this, just ignore this question.

Regarding the above assets classes: When I look at my portfolio I do have some exposure to intermediate govt though Pimco is underweight US Treasury, and overweight TIPS + foreign (see M*). My total bond market has a good size chunk of US intermed Treasury. Also I own a large chunk of large-cap US value index.

In equities in addition to US large cap, I have US Mid-cap and Small-cap, plus foreign large-cap and mid-cap, and a big chunk of REITS. In bonds, I have several diversified intermediate bond funds that have a lot of corporate debt, GNMA fund and municiple bond fund, plus a multi sector bond fund that has foreign debt, emerging market debt barbelled with treasuries/TIPs (FSICX).

 

[MichaelB]

In equities in addition to US large cap, I have US Mid-cap and Small-cap, plus foreign large-cap and mid-cap, and a big chunk of REITS. In bonds, I have several diversified intermediate bond funds that have a lot of corporate debt, GNMA fund and municiple bond fund, plus a multi sector bond fund that has foreign debt, emerging market debt barbelled with treasuries/TIPs (FSICX).

Most of these asset classes are not considered in Wade's pessimistic projection. Add to that emerging market equities and commodities. If a portfolio is exposed to a wide variety of these it has a greater chance of surviving.

 

[marko]

In short we have a lot of people that would be benefit from high inflation and relatively small class of savers who are hurt by it. .

But wouldn't inflation be attacked by the gov't raising interest rates and thereby help savers with higher yields/returns?

 

[audreyh1]

Most of these asset classes are not considered in Wade's pessimistic projection. Add to that emerging market equities and commodities. If a portfolio is exposed to a wide variety of these it has a greater chance of surviving.

Exactly! Which is why I'm hoping my more diversified allocation will translate to a better portfolio survival. It certainly outperformed the traditional large-cap/US-bond balanced funds in the late 00's.

I don't own commodities or emerging market equities directly, but I know some of my funds hold this stuff directly or indirectly (actually, one of them holds quite a bit of commodity related stuff like Ag and Oil). And even big US companies sell into emerging markets.

At times I have considered adding something like Fidelity Strategic Real Return to my allocation (mix of REITs, commodities, floating rate loans and TIPs), but frankly, I have been slow to act on this point simply because I expect the global slowdown to last for a while.

 

[Lsbcal]

Here is an interesting view of the markets for the last 18 years. Plot shows Emerging Mkts, SP500, European, and Pacific. I think Pacific suffered from the Japan exposure:

Also plotted these for 3 year (36 month) rolling return periods:

 

[MichaelB]

Exactly! Which is why I'm hoping my more diversified allocation will translate to a better portfolio survival. It certainly outperformed the traditional large-cap/US-bond balanced funds in the late 00's.

I don't own commodities or emerging market equities directly, but I know some of my funds hold this stuff directly or indirectly (actually, one of them holds quite a bit of commodity related stuff like Ag and Oil). And even big US companies sell into emerging markets.

At times I have considered adding something like Fidelity Strategic Real Return to my allocation (mix of REITs, commodities, floating rate loans and TIPs), but frankly, I have been slow to act on this point simply because I expect the global slowdown to last for a while.

This is GMO's most recent 7 year forecast

This is their forecast 10 years ago

and this is a look at 10 years actual performance of 4 major equity classes reflected in the S&P and 3 DFA funds over the past 10 years.

Just a graphical view of the point I made earlier. Which is the bigger risk for the new retiree withdrawing 4%? Low expected returns or a portfolio limited to US investments?

Finally, a paper here by GMO on investing in emerging country debt. Registration is required by no fee or spam. Well worth it IMHO.

 

[Lsbcal]

Interesting GMO comparison, thanks Michael. Grantham got the differential between international and US right at the beginning of 2003.

Somewhat sobering future gain prospects, if you can believe any forecasts. I do not understand why US equities are shown forcast so low. And a differential of about 5% compounded between US and International -- seems hard to believe. Anyone care to explain or have a link to the GMO explanation?

 

[EvrClrx311]

Interesting... I wonder how they came to the prediction that both international and us small stocks will trail large caps? If that actually happens, it'll be a rare event (has happened before but not often)

Might be that it occurred over the last decade (and they missed it in their 2002 numbers) so they're swinging too far back in their forward projections thinking it'll happen again for the next decade?

FWIW, I'm very confident in small/mid caps right now... looking ahead 10 years. Enough to invest 40% of my 401k in them through index funds

 

[ziggy29]

This whole thing feels like recency bias to me. We "feel" like equity returns are going to stink like they have for the last 12 years and assume the long term will be the same.

 

[audreyh1]

I think Grantham's models are more based on returning to the long-term mean for each asset class - the opposite of recency bias. Govt bonds are overvalued with respect to their traditional values, so Grantham predicts underperformance over the next 7 years. According to their model, international and emerging market stocks are undervalued relative to US stocks, so they expect them to outperform US stocks over the next 7 years.

Note that his model predicts equities will outperform bonds over the next 7 years. He's not saying equities stink on a relative valuation basis. But yes, he is expecting that global growth over the next 7 years will be constrained compared to the past couple of decades, so that aspect could be considered recency bias.

Grantham's 7 year model is updated quarterly, so as asset classes grow or decline, they affect the 7 year (rolling) model.

 

[audreyh1]

Interesting... I wonder how they came to the prediction that both international and us small stocks will trail large caps? If that actually happens, it'll be a rare event (has happened before but not often)

Might be that it occurred over the last decade (and they missed it in their 2002 numbers) so they're swinging too far back in their forward projections thinking it'll happen again for the next decade?

FWIW, I'm very confident in small/mid caps right now... looking ahead 10 years. Enough to invest 40% of my 401k in them through index funds

I think the predicted underperfomance is based on the current economic environment - less economic stability, harder to obtain credit, less exposure to international developing markets (for US small cap stocks). The current slow-growth tight-credit environment favors large companies over small. Small caps do better under higher growth conditions.

Anyway - I suspect that's were they are comping from. I hold mid and small cap too, simply because in the long run I expect it to pay off. In the short run - who knows?

 

[Lsbcal]

Interesting... I wonder how they came to the prediction that both international and us small stocks will trail large caps? If that actually happens, it'll be a rare event (has happened before but not often)

Might be that it occurred over the last decade (and they missed it in their 2002 numbers) so they're swinging too far back in their forward projections thinking it'll happen again for the next decade?

FWIW, I'm very confident in small/mid caps right now... looking ahead 10 years. Enough to invest 40% of my 401k in them through index funds

I have some overweighting (versus market) to mid/small caps for the long term. As you say there have been periods of large cap outperformance. Not exactly a rare event though. Here is a long term picture showing 5 year (60 months) rolling returns for large, small, and midcaps. The mid-caps are just charted for about the last decade.

It seems that in general periods of small cap out performance are followed by periods of under performance. Would be interesting to see relative PE ratios (large vs small cap) for the long term but I don't have that data.

 

[brewer12345]

This whole thing feels like recency bias to me. We "feel" like equity returns are going to stink like they have for the last 12 years and assume the long term will be the same.

Here, have a cigar.