Wade Pfau looks at 4% WR, finds it unsafe

[Midpack]

very similar things were said in 1873, 1896, 1913, 1929, 1954, 1973, 2000

"this time its different..." is nothing new. It's human nature to think what we're experiencing today won't fit the models of yesterday... that somehow we'll never get back to the prosperity we saw before. It's the very thing that by nature makes humans horrible investors.

I challenge you to bookmark this comment and come back to look at it in 20 years (10 years might even be enough to show it). I can all but guarantee you that we'll see 5%+ real market returns (8.5%+ actual) between now and then for the S&P500.

If somehow you are correct that the next 20 years fall outside the rules the last 250+ have followed, then I'll call you a genius... or lucky. Either way you can have a good laugh at my expense.

Bookmarked!

All true enough and I hope you're right! I hope for average or better real returns and it's certainly possible, but I'm prepared for lower real returns and have contingency plans just in case.

 

[W2R]

I hope for average or better real returns and it's certainly possible, but I'm prepared for lower real returns and have contingency plans just in case.

Like I try not to expect or depend on very high returns. Then if they happen, it's a nice surprise.

If an SWR of around 2% takes me to age 100 (another 36-37 years), I'll won't be in the least bit disappointed. If the market thrives, it'll be Christmas every day at my house.

 

[EvrClrx311]

Like I try not to expect or depend on very high returns. Then if they happen, it's a nice surprise.

If an SWR of around 2% takes me to age 100 (another 36-37 years), I'll won't be in the least bit disappointed. If the market thrives, it'll be Christmas every day at my house.

That is the best mindset IMO...

If financial Armageddon is coming... planning on soaking up rays at the beach won't be on my mind... or anyone's for that matter. Finding food/shelter will be.

If you can survive (food/basics covered) the extreme worst we've seen in history, you'll be more than ok and pleasantly surprised when you see what actually happens (something close to average)

 

[audreyh1]

I'm still trying to get my head around how a balanced portfolio behaves in a financial repression scenario. The 1945 to 1980 time period is a bit too long as it included one secular bull and one secular bear scenario. I don't even begin to know how to model what a financial repression period means in the stock or bond markets. Any suggestions?

 

[samclem]

"this time its different..." is nothing new. It's human nature to think what we're experiencing today won't fit the models of yesterday... that somehow we'll never get back to the prosperity we saw before.

I'm just suggesting there's value in stepping back and looking at the bigger picture. From one perspective it is you that is saying "this time it's different"--because you are saying the US will have a different experience than other world-beating economies. "This country is different--it won't get fat and noncompetitive, it won't be overtaken by other economies, its population won't demand redistribution of capital that (whatever other benefits they produce) undeniably move money from places of highest expected return to places of lesser expected return."

If somehow you are correct that the next 20 years fall outside the rules the last 250+ have followed, then I'll call you a genius... or lucky. Either way you can have a good laugh at my expense.

Hey, if our economy underperforms I certainly won't be laughing. Neither of us will, I'm sure.

In 1900, US equities were 22% of the world market. By 2000, they were 47% of the world market. When we discuss "average" equity returns, should we concentrate on the one nation that so obviously outperformed the rest of the world over this particular time period? Are the same factors in place that allowed US outperformance during that period?

And "250 years?" Nobody thinks we have accurate data on equity returns going back to the 1760s.

 

[Lsbcal]

I'm still trying to get my head around how a balanced portfolio behaves in a financial repression scenario. The 1945 to 1980 time period is a bit too long as it included one secular bull and one secular bear scenario. I don't even begin to know how to model what a financial repression period means in the stock or bond markets. Any suggestions?

The chart below is from a Bill Gross article of August 2003 that I saved. I think you might be able to get the full Outlook article by going to his Pimco site and looking in the archives. The chart shows government short term Treasury real rates and the idea is that the government can totally control the short term rates. Financial repression is then defined (I think) as when those real rates go negative for long periods. Currently the government is even pushing to control longer term rates. The current 3mo Tbill real yield is roughly 0.08% - inflation, or roughly the negative of the inflation rate.

BTW, I'd highly recommend Gross's monthly Outlook articles. Many people (several Bogleheads) kind of hate his guts but he is not referred to as the "bond king" for nothing. He cannot predict the future but IMO he is entertaining and insightful at times. Link to his articles: PIMCO | Insights - Investment Outlook

 

[brewer12345]

So you bastards are conspiring with Dr. Pfau (image of someone sinister stroking a cat) to ensure I will never be able to retire, eh? Pfooey.

 

[Onward]

very similar things were said in 1873, 1896, 1913, 1929, 1954, 1973, 2000

But our vision is so much clearer now!

 

[Nords]

UPDATE: I did get a response! http://www.early-retirement.org/forums/f28/annuity-as-plan-a-versus-plan-b-61602.html

He's a different type of economist.

He's relatively young and it's too unfair to compare him to those who are [-]older[/-] more established in their fields, but he definitely does a better job of communicating with his readers. He has a very clear writing style, he's not afraid to discuss what the meat grinder is doing to the sausage, and he writes to a very wide spectrum of different outlets.

I guess he's much more responsive to and more collaborative with his audience. Compare that to guys like Bernstein who eventually stopped posting at Bogleheads, or guys like Swedroe who got tired of being called out. I know they're not economists, but off the top of my head I can't even think of an economist who posts to discussion boards and has a blog... let alone one who promptly answers reader's e-mails.

I'm enjoying watching a very bright light being shined into some unexplored places.

 

[obgyn65]

Interesting comment... I have an opposite view. I think our global econonic prospects are darker. Advances and economic progress will only benefit the few, not the masses. And I am very worried about a future nuclear armed Iran.

Personally I think the future global economic prospects are considerably brighter than current returns on capital indicate. A billion consumers who a decade ago were living on subsistence agriculture in China, India, Brazil etc. now want, need and most important can buy goods and services. While the superior return of US equities of the 20th century may not be repeated, I also don't see repeat of two world wars, or a awful system like communism taking over 1/3 of the world and dragging down international equity returns.

 

[MichaelB]

I'm enjoying watching a very bright light being shined into some unexplored places.

+1

 

[Lsbcal]

...(snip)...
I guess he's much more responsive to and more collaborative with his audience. Compare that to guys like Bernstein who eventually stopped posting at Bogleheads, or guys like Swedroe who got tired of being called out. I know they're not economists, but off the top of my head I can't even think of an economist who posts to discussion boards and has a blog... let alone one who promptly answers reader's e-mails.

I'm enjoying watching a very bright light being shined into some unexplored places.

I appreciate people such as Bernstein and Swedroe even though they tend to be broadcasters of their ideas with only a mild tilt to interactive. However, they do tend to respond to short questions. Swedroe seems to really like responding when the interaction gets rough, I think he loves an argument.

Phau could be a breath of fresh air. I appreciate his candor. At Bogleheads it gets so long and contentious because some Bogleheads like to go on ... and on ... and on. Many of them don't seem to know how to make a concise point. I just turn it off after awhile. Here is an example, on a PE10 thread I posted a chart which showed the extreme increase in standard deviation of average 10 year earnings over recent years. Some Bogleheads got it but many seemed to totally ignore the points. They preferred to go on ... and on ... and on making their points. Well they don't call this stuff social forums for nothing I guess. I have to be patient and realize this is part cocktail hour chatter.

 

[audreyh1]

The chart below is from a Bill Gross article of August 2003 that I saved. I think you might be able to get the full Outlook article by going to his Pimco site and looking in the archives. The chart shows government short term Treasury real rates and the idea is that the government can totally control the short term rates. Financial repression is then defined (I think) as when those real rates go negative for long periods. Currently the government is even pushing to control longer term rates. The current 3mo Tbill real yield is roughly 0.08% - inflation, or roughly the negative of the inflation rate.

BTW, I'd highly recommend Gross's monthly Outlook articles. Many people (several Bogleheads) kind of hate his guts but he is not referred to as the "bond king" for nothing. He cannot predict the future but IMO he is entertaining and insightful at times. Link to his articles: PIMCO | Insights - Investment Outlook

Hi Lsbcal!

I am familiar with the PIMCO work, and I perhaps their "new normal" is another way of describing the financial repression scenario we are currently in, or some related variant. Honestly, I cannot get through Gross's Outlooks sermons - they are just too wordy for me. I occasionally read one, and maybe I get his points, but they are often lost on me. Plus, he was so off last year on his avoidance of US Treasuries. His concerns were that interest rates would rise? This goes against the Financial Repression scenario, so with Gross I end up confused. And I'm just not willing to parse his difficult language when he seems (to me at least) terribly inconsistent.

Jeremy Grantham 7 year forecast does seem to illustrate the Financial Repression scenario as he predicts real returns for several bond classes* as negative over the next 7 years.

Several of my Morningstar buddies point out that Grantham's forecast is focused on Govt bonds, and ignores other fixed income types such as Corporate bonds, Muni bonds, and High-yield debt. Personally, only a portion of my bond allocation is Govt bonds, and that more in Municipal and GNMA - not much in Treasury bonds and none in TIPs. I'm not worried about interest rate risk in the near future, and I'm hoping the more diversified bond allocation plus >50% allocation to equities including REITs will help me get through this "financial repression" era.

* Grantham's Bond Asset Classes (from http://whitecoatinvestor.com/gmo-real-return-forecasts/)

US Bonds = Treasury Bonds
Intl Bonds = International Govt Bonds
Emerging Debt = Emerging Market Bonds
Index Linked Bonds = TIPS
Cash = Cash/Treasury Bills

FWIW - link to updated April 30, 2012 GMO forecast can be found on this page: http://www.gmo.com/America/MyHome/

Audrey

 

[Lsbcal]

Hi Lsbcal!

I am familiar with the PIMCO work, and I perhaps their "new normal" is another way of describing the financial repression scenario we are currently in, or some related variant. Honestly, I cannot get through Gross's Outlooks sermons - they are just too wordy for me. I occasionally read one, and maybe I get it points, but they are often lost on me. Plus, he was so off last year on his avoidance of US Treasuries. His concerns were that interest rates would rise? This goes against the Financial Repression scenario, so with Gross I end up confused. And I'm just not willing to parse his difficult language when he seems (to me at least) terribly inconsistent.

Hi Audrey, I know that Gross gets quite poetic in his Outlook monthly. Sometimes I just dive to the bottom and read the bold print, then read backwards to understand the message and reasoning. Occasionally there is a really good chart like the Ring of Fire chart showing countries in trouble that he posted a few years back and that are so in the news now.

He was definitely off on US Treasuries but has made up a lot of the lost ground. If comparing PTTRX to maybe VBTLX (Total bond mkt) I'd use rolling 3 or 5 year returns. PTTRX has done better in the past -- the future is never clear. This is my only non-index position.

Interest rates rising is not inconsistent with Financial Repression if we describe FR as negative real rates for extended periods. Also should mention one person's FR is another person's life line. Although negative real rates are ugly for the fixed income crowd, the cheap money hopefully should help to get people to take risks and goose the economy and increase employment (in some theories at least).

Jeremy Grantham 7 year forecast does seem to illustrate the Financial Repression scenario as he predicts real returns for several bond classes as negative over the next 7 years.

Grantham's 7 year chart seems to be consistent with the facts.

Several of my Morningstar buddies think that there are other bond/fixed income classes that Grantham hasn't modeled that may do OK, but who knows.

I like PTTRX and the new ETF version BOND because I think bonds are a mine field right now. But I also have some Total Bond Mkt. FWIW, I'm will to move to Treasuries if they outperform or even cash using a predefined timing mechanism should rates move substantially higher. Just saying this because my positions are buy-hold-but-occasionally-switch so buy-hold people can just ignore my investment positions.

 

[audreyh1]

Interest rates rising is not inconsistent with Financial Repression if we describe FR as negative real rates for extended periods. Also should mention one person's FR is another person's life line. Although negative real rates are ugly for the fixed income crowd, the cheap money hopefully should help to get people to take risks and goose the economy and increase employment (in some theories at least).

Yes, that's true (that history shows periods of Financial Repression with high interest rates). However, I am making another couple of assumptions: that global growth will be weak and that this means inflation will be restrained, if not occasional bouts of deflation; and that given the debt overhang, govts around the world will absolutely not raise interest rates in face of weak employment and weak economies. That is why I am not worried about interest rate risk over the next several years. And, yes, the cheap money should continue to help business which makes me feel better about the equity side of my portfolio.

 

[Lsbcal]

Yes, that's true (that history shows periods of Financial Repression with high interest rates). However, I am making another couple of assumptions: that global growth will be weak and that this means inflation will be restrained, if not occasional bouts of deflation; and that given the debt overhang, govts around the world will absolutely not raise interest rates in face of weak employment and weak economies. That is why I am not worried about interest rate risk over the next several years. And, yes, the cheap money should continue to help business which makes me feel better about the equity side of my portfolio.

Yep, that is certainly the trend. I think we can say for sure that competition in societies and between countries will continue to be intense.

But note politicians are now talking about growth agendas (Europe except maybe for the Germans) more explicitly. Rates are anticipatory by the market. If there is enough political push the fires of growth could be started and we could get a surprise. Maybe good for stocks and bad initially for bonds. Governments might find they are behind in rate control on the longer end of the yield curve as the private markets take over. In the US government might welcome the chance to give back control to private market forces.

I just mention this because it might be useful to also visualize an alternate outcome. I'm not betting either way as I've set my strategy to go with the flow.

 

[audreyh1]

I just think between the boomer retirees clamoring for yield, and the lack of demand for money to fund economic expansion, the "fires of growth" are just going to be barely burning for quite a while no matter what the politicians devise. With no wage pressures, and now commodities dropping due to slowing global economies, I just don't see an inflation surprise any time soon - the drivers just aren't there.

 

[samclem]

With no wage pressures, and now commodities dropping due to slowing global economies, I just don't see an inflation surprise any time soon - the drivers just aren't there.

I'd agree that many of the traditional drivers are absent now. But the US public debt level is so high, and the temptation to use devalued currency as a way out of the situation will be so tempting, that I think it's a significant risk. Other alternatives (higher taxes or lower govt spending to enable higher debt service payments) just aren't in the cards--we may just be institutionally incapable of doing them. Inflation will be seen as the least bad option, and the easy money provided by a monetary expansion will keep the economy moving and the electorate satisfied--for the short term. And the "short term" seems to drive almost everything.

 

[Lsbcal]

I just think between the boomer retirees clamoring for yield, and the lack of demand for money to fund economic expansion, the "fires of growth" are just going to be barely burning for quite a while no matter what the politicians devise. With no wage pressures, and now commodities dropping due to slowing global economies, I just don't see an inflation surprise any time soon - the drivers just aren't there.

In the 1980's we had high real rates, growth and declining inflation. Do we really need high inflation to get growth?

I know this time really isn't the same but I'd avoid using my understanding of economics to make investment decisions. Not that I think some people here are doing that . There are too many moving parts and too many faulty models.

Another thought, if real rates went up retirees would eventually come to love it (after the rate increase shock ebbs). With all the competitive pressures people are just glad to have a job -- at first. So wage demands would be low perhaps for some years. Just some wild thoughts.

 

[clifp]

I'd agree that many of the traditional drivers are absent now. But the US public debt level is so high, and the temptation to use devalued currency as a way out of the situation will be so tempting, that I think it's a significant risk. Other alternatives (higher taxes or lower govt spending to enable higher debt service payments) just aren't in the cards--we may just be institutionally incapable of doing them. Inflation will be seen as the least bad option, and the easy money provided by a monetary expansion will keep the economy moving and the electorate satisfied--for the short term. And the "short term" seems to drive almost everything.

I agree. I'd add that it isn't just US government debt that is high. We have state and local debt at very high levels and the same is true for developed country debt (Europe/Japan). Nor is it just government debt, personal debt while coming down is still near record level. (I suspect as a percentage of debt to asset, debt levels for consumer is probably at a record level. The housing price collapsed and stocks are down slightly from the peak and saving have been depleted for many people)

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. It is true us inflation prophets have been proven wrong for a number of years. However, with so many people benefiting from high inflation, and the victims including people like Saudi kings, and Chinese klepocrats I fear us savers are going to be viewed as collateral damage. To put it another way the one big driver of inflation is the determination of governments to make it happen.

 

[MichaelB]

There are only two kinds of inflation. 1) Not enough 2) Too much. No matter which one we have, it's the other we want. The biggest losers from each type of inflation are the same: retired people.

There are still billions of people in the world with very low incomes and lots of opportunity for the world economy to grow. We are probably just in a normal global business cycle that looks bad now but will be much different in a year or two.

 

[marko]

We are probably just in a normal global business cycle that looks bad now but will be much different in a year or two.

I hope to God you're right!

 

[audreyh1]

I know this time really isn't the same but I'd avoid using my understanding of economics to make investment decisions. Not that I think some people here are doing that . There are too many moving parts and too many faulty models.

Another thought, if real rates went up retirees would eventually come to love it (after the rate increase shock ebbs). With all the competitive pressures people are just glad to have a job -- at first. So wage demands would be low perhaps for some years. Just some wild thoughts.

I also don't make investment moves based on my economic outlook - other than trying to be well diversified so that I am not stuck in two simple, and likely expensive, asset classes (i.e. intermediate govt bonds, large-cap US stocks) like the portfolio survival models seems to favor.

Will retirees love it when the real rates go up? I don't think so, because IMO it will likely be accompanied by increased inflation that might hurt them even worse.

FWIW - I think The Fed has been trying to get inflation to increase for a couple of years now, and they have not been successful. I don't think it's that easy to do absent other drivers, and IMO a large debt overhang simply isn't enough. Japan hasn't been successful either.

Audrey

 

[Lsbcal]

I also don't make investment moves based on my economic outlook - other than trying to be well diversified so that I am not stuck in two simple, and likely expensive, asset classes (i.e. intermediate govt bonds, large-cap US stocks) like the portfolio survival models seems to favor.
...

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.

 

[Nords]

Interesting comment... I have an opposite view. I think our global econonic prospects are darker. Advances and economic progress will only benefit the few, not the masses. And I am very worried about a future nuclear armed Iran.

Have you read the book "Abundance"? The reason I'm asking is that there are several behavioral-psychology reasons behind having such a bleak outlook, and there are several technological improvements that give more cause for optimism.

There are many other nuclear countries that are far more deadly than Iran. There. Does that make you feel better?

Hi Audrey, I know that Gross gets quite poetic in his Outlook monthly.

I used to read his columns, but I got tired of having to look up every third word in my Oxford English Dictionary...

I agree. I'd add that it isn't just US government debt that is high. We have state and local debt at very high levels and the same is true for developed country debt (Europe/Japan). Nor is it just government debt, personal debt while coming down is still near record level. (I suspect as a percentage of debt to asset, debt levels for consumer is probably at a record level. The housing price collapsed and stocks are down slightly from the peak and saving have been depleted for many people)
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. It is true us inflation prophets have been proven wrong for a number of years. However, with so many people benefiting from high inflation, and the victims including people like Saudi kings, and Chinese klepocrats I fear us savers are going to be viewed as collateral damage. To put it another way the one big driver of inflation is the determination of governments to make it happen.

Another possibility is the way we've changed the accounting rules in the last 30 years. Now that municipal & state govts actually have to account for their pension/healthcare liabilities (to say nothing of the Dept of Defense), the debt burden is much harder to ignore.

In other words, I think we're making progress just by raising our awareness.