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Does a Hybrid Total Return/Bucket Approach Work?
Old 05-17-2018, 04:07 PM   #1
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Does a Hybrid Total Return/Bucket Approach Work?

So I have been noodling and running some different "what if" models as I tentatively plan to launch RE at the end of 2019 (age 55). Mathematically, I have personally settled in on a 60/40 AA based on what I believe to be my sweet spot and for now, plan on riding that through RE until/if I discover a better mousetrap. Additionally, I have bought into the Total Return philosophy with plans to rebalance every year. While naturally dividends/interest will first fill my yearly expense bucket, I anticipate the balance to come from annual rebalancing. I have run some simple models using simple stock/bond mutual funds over 10 - 15 yr periods purposely including the great recession to get a sense of where my overall balances would fall year after year before and after rebalancing. I did this to get a sense of my risk tolerance as well as see how the balances recovered and how soon. Interestingly, while the balances from year to year were volatile, particularly during the great recession, the ending balance was above where I started the analysis as of the end of 2017. While this gives me some confidence of my strategy (at least using this snapshot in time), it has me wondering if a combination bucket strategy would 1) give me/most people a better sleep at night during significant down markets and 2) close to the same ending balance?

Assume for a min you are 60/40 and you buy into the 4% rule (what I do). Your 40% effectively covers 10 yrs of expenses. Using a hybrid bucket strategy, if equities crap out for 3, 5, 7, God forbid 10 years, you would live out of your 40% and just let your equities ride. There is a part of me that says I might be able to make more peace with this strategy as it may make me feel like I have my 10 yrs of living expenses "safe" and therefore basically ignore any extended downturn in equities. Alternatively, if I stay as a Total Return purist, I will probably end up buying more equities during rebalancing in certain years which will further deplete my "safe" money. Again, my analysis proves this works, but just a little more volatile.

Anyone follow my drift here? Did any of you great recession RE-ed folks who follow a Total Return approach end up doing a hybrid bucket??
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Old 05-17-2018, 09:16 PM   #2
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I am not a great recession RE-folk. But I did go through the great recession at 100% stocks. But I was still working then. I retired 2 years ago at age 46.

I personally don't like the bucket approach. The relaxation you may feel from living off fixed income during a downturn would be counterbalanced in my case by two concerns: (1) As I deplete my fixed income side, my portfolio is getting more aggressive because that original 60/40 ends up looking like 90/10 after a few years, and (2) What decision rules do I have for when to replenish the fixed income side, and what pressures will I feel to second guess those decision rules if the future plays out in a way I don't expect? I personally would not feel comfortable with subjective decision rules or ones that have not been backtested and shown to work.

I wouldn't look at bonds as "safe" money and stocks as "risky" money. I personally try to make my overall AA the least risky based on my goals, resources, backup plans, and opinion about future and what risks I face. Since I look at a planning horizon of 40 years and view maximum historical SWR as a decent proxy for minimizing risk of portfolio depletion, I aim for a 90/10 allocation and rebalance at least annually or whenever my allocation strays by 2 percentage points in either direction (this latter criteria has yet to occur in my case).
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Old 05-18-2018, 04:25 AM   #3
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Keep in mind that if interest rates rise, the value of the bonds will fall.
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Old 05-18-2018, 05:14 AM   #4
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I am not a great recession RE-folk. But I did go through the great recession at 100% stocks. But I was still working then. I retired 2 years ago at age 46.

I personally don't like the bucket approach. The relaxation you may feel from living off fixed income during a downturn would be counterbalanced in my case by two concerns: (1) As I deplete my fixed income side, my portfolio is getting more aggressive because that original 60/40 ends up looking like 90/10 after a few years, and (2) What decision rules do I have for when to replenish the fixed income side, and what pressures will I feel to second guess those decision rules if the future plays out in a way I don't expect? I personally would not feel comfortable with subjective decision rules or ones that have not been backtested and shown to work.

I wouldn't look at bonds as "safe" money and stocks as "risky" money. I personally try to make my overall AA the least risky based on my goals, resources, backup plans, and opinion about future and what risks I face. Since I look at a planning horizon of 40 years and view maximum historical SWR as a decent proxy for minimizing risk of portfolio depletion, I aim for a 90/10 allocation and rebalance at least annually or whenever my allocation strays by 2 percentage points in either direction (this latter criteria has yet to occur in my case).
So do you plan on staying 90/10 thru RE? Are your investments your only source of income (as opposed to a pension, working spouse, hobby/side job income)? Total Return investor or Dividend investor? SWR?

Sorry for all the questions, but you don't find many who keep their AA as heavily weighted in equities during RE unless they have a ridiculously low SWR or have other reliable income sources covering their nut. In my case, I am 100% dependent on my investments, so real world examples from people who have been running the race in RE and how they have been implementing their plans (particularly if they are 100% dependent on their investments) interests me.
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Old 05-18-2018, 05:22 AM   #5
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I agree with you that at the points you are rebalanced that 60/40 and buckets are pretty similar. I was still working during the great recession, and I was paralized like a deer in the headlights. While I didn't sell equities and continued buying equities with contributions as I had prior to the recession, I could not find the courage to sell bonds and buy equities despite my AA screaming at me to do that.

What would I have done if it happened now?... I dunno but suspect that I would just hang on and live off bonds for a while given what I experienced in 2008-2009. That said, I think/hope that the great recession was a once in a lifetime event.
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Old 05-18-2018, 05:24 AM   #6
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Keep in mind that if interest rates rise, the value of the bonds will fall.
True, of course. I am using the term "bond" in somewhat of a generic sense to include cash/MMKT, CDs. While by my test run I noted before showed an occasional small loss for intermediate bonds in certain years, it was generally a 1 yr event. My thought experiment here is IF you somehow believed in the hybrid approach, you might layer your bond allocation a little differently than you would as a pure Total Return investor. As eg, maybe you would have 1 - 2 yrs in MMMTs, 2+ years in laddered CDs, and some bond pool for the rest.

I am really just spit balling here with this thread to see if any/many Total Return investors leaned into a "bucket" approach during periods like the great recession because they just chickened out on a rebalance 1 or more years when stocks were plummeting.
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Old 05-18-2018, 05:31 AM   #7
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I agree with you that at the points you are rebalanced that 60/40 and buckets are pretty similar. I was still working during the great recession, and I was paralized like a deer in the headlights. While I didn't sell equities and continued buying equities with contributions as I had prior to the recession, I could not find the courage to sell bonds and buy equities despite my AA screaming at me to do that.

What would I have done if it happened now?... I dunno but suspect that I would just hang on and live off bonds for a while given what I experienced in 2008-2009. That said, I think/hope that the great recession was a once in a lifetime event.
You are kinda making my point. There is the "plan" and then there are the real life events which affect our willingness to pull the trigger. I would like to think I learned allot about myself and markets in general during the big recession. I was 80/20 then and watched 7 figure paper losses. I did panic "some" and sell about 20%, but soon after convinced myself to get back in (I had to have a stern talk with myself and what/how long I was investing for!) so nothing was really lost in the long run. None the less, I would LIKE to think I learned some valuable lessons and I will have a "steadier hand on the wheel" come next time (hopefully not a 2008 next time!).
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Old 05-18-2018, 08:49 AM   #8
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What would I have done if it happened now?... I dunno but suspect that I would just hang on and live off bonds for a while given what I experienced in 2008-2009. That said, I think/hope that the great recession was a once in a lifetime event.
Emphasis added by me.

I am afraid it isn't. For those of us with a few more years, we also lived through 73-74 Oil crisis stock market collapse. Granted my investments at that point in time did not add up to a hill of beans, but 2008-2009 was #2 for many of us.

I guess that is why I still have a very healthy fear of The Bear and what its powerful paws can do to one's assets. That said, I don't invest if fear, rather I invest with an eye to diversification. It's nice to have more than one hiding place if The Bear comes hunting for new prey.
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Old 05-18-2018, 10:15 AM   #9
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So do you plan on staying 90/10 thru RE? Are your investments your only source of income (as opposed to a pension, working spouse, hobby/side job income)? Total Return investor or Dividend investor? SWR?

Sorry for all the questions, but you don't find many who keep their AA as heavily weighted in equities during RE unless they have a ridiculously low SWR or have other reliable income sources covering their nut. In my case, I am 100% dependent on my investments, so real world examples from people who have been running the race in RE and how they have been implementing their plans (particularly if they are 100% dependent on their investments) interests me.
Oooh, I like answering questions! :-)

Yes, I plan on staying at least 90/10 for at least the next 20 years or so. More precisely, my plan is to first assess my planning duration every few years based on my current health status and age; currently I am 49 and in good health so I use 40 years. Second, I will look at tools like FIREcalc to assess what the AA is that produces the highest historical SWR; currently it is basically 4% at 90/10. Finally, I am considering adding an additional step of partitioning my portfolio into two logical parts: "my" part which my current withdrawal equals 4% of and should be allocated at 90/10, and "my kids" part, which my withdrawal is 0% of and should be allocated at 100% stocks. If I were to implement this third step today, my overall allocation would be about 95/5.

As I get older and my planning horizon shortens, the highest historical SWR tends to be associated with higher bond allocations. I reserve the right to shift more to bonds at that point. That being said, I think in 20 years or so my withdrawal rate will be very low, so I may elect not to do so.

I did not retire until my expenses were under 4% of my FIRE stash and I assumed zero non-portfolio income. That being said, I do have some non-portfolio income that I gladly receive and use for regular daily spending as it has come in. I do not have a spouse nor a pension. I do have a variety of small sources of income (side gigs, gifts, refundable tax credits, credit card games) that equal about 1.2% of my FIRE stash.

I am a total return, costs matter, long term buy and hold index mutual fund investor. My stock allocation generally is in VTSAX, my bond allocation is generally in VBTLX. I follow the basic approach of maintaining my AA over long periods of time, withdrawing what I need and rebalancing the remainder occasionally (although, as mentioned elsewhere, I rebalance more often than is necessary).

I calculate my WR based on my last six months' actual expenses from Quicken. As of a day or so ago, my WR is at 3.06%. Subtracting the 1.2% non-portfolio income, that puts me at an effective 1.8% WR or so. Since the last six months includes December, which is my most expensive month historically due to property taxes, Christmas, and some credit card fee expenses (which I more than make up for through credit card games, but still obviously count as expenses), I would expect my calculated WR to drop in the next month or so to perhaps 2% gross, 1% net. Whether that qualifies as a "SWR" or "ridiculously low" is up to everyone to decide for themselves, but I feel comfortable with it. In fact, I'm trying to spend a little more.

There are a couple of other things I'll add:

1. I've historically had a high tolerance for risk and volatility. My Dad invested in stocks for me at an early age and was optimistic about stocks and the United States as early as the early 1980's. I have always been emotionally detached about investments, and so I essentially have been invested 100% in stocks from the mid-1980's through 2016, when I backed off to 90/10 because I had retired and suspected I needed something to do (rebalance) during the next market pullback.

2. I don't really have any fancy needs. I'm happy just not working and puttering around, volunteering at my kids' schools, playing bridge, working out at the gym, donating platelets to the Red Cross, tending to my yard and house, etc. I live in a flyover state which has low costs of living. I occasionally but regularly see posts from people who spend more on healthcare or property taxes than I spend on everything.

3. I do have quite a number of very reasonable backup plans for increasing income and/or reducing expenses if I need to. I collected these and documented them and know they are there in case my FIRE plan ever starts to look wonky.

4. Everyone worries about bad luck happening in their retirement. I know bad luck happens, but people seldom mention that things can turn out better than planned also. I have been lucky in this regard: Since I retired in February 2016, the market and thus my investments have done much better than I expected. I received some life insurance that I knew about but wasn't planning on receiving. I planned on zero side income but as noted above have non-portfolio income that represents, effectively, a -1.2% WR. A company in which I owned stock got bought by a Fortune 500 company so I received some money from that. If I play bridge with the right people I can make a few bucks a year (literally, like $10 last year).

Everyone has to decide for themselves what's best for their goals and situation, but I feel pretty comfortable for now with mine.
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Old 05-18-2018, 10:44 AM   #10
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I find this thread very interesting and hope to learn some things from you smart people out there.
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Old 05-18-2018, 11:59 AM   #11
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OP may want to read this article from Darrow Kirkpatrick.
https://www.caniretireyet.com/new-re...al-strategies/

He's not advocating a bucket method, but discussing alternatives for how to draw down from different parts of your asset allocation. Unless you intend to just withdraw pro-rata from every asset class, you will be making implicit market timing decisions, so it may be helpful to at least know what strategies have worked in the past. (That being said, I am not advocating any of these strategies. I thought they were useful as a thought experiment, but they are all back-tested, so put on your "past performance does not indicate future results" goggles).

With those caveates out of the way, the method discussed as the most efficient in the article would be to sell equities when they are above their mean long term CAPE valuation and sell fixed income whenever that is not the case. If applied during a bad bear market, this would help maintain your pre-recession asset allocation, since the price collapse of equities would have shifted your AA to fixed income.
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Old 05-18-2018, 12:46 PM   #12
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OP may want to read this article from Darrow Kirkpatrick.
https://www.caniretireyet.com/new-re...al-strategies/

He's not advocating a bucket method, but discussing alternatives for how to draw down from different parts of your asset allocation. Unless you intend to just withdraw pro-rata from every asset class, you will be making implicit market timing decisions, so it may be helpful to at least know what strategies have worked in the past. (That being said, I am not advocating any of these strategies. I thought they were useful as a thought experiment, but they are all back-tested, so put on your "past performance does not indicate future results" goggles).

With those caveates out of the way, the method discussed as the most efficient in the article would be to sell equities when they are above their mean long term CAPE valuation and sell fixed income whenever that is not the case. If applied during a bad bear market, this would help maintain your pre-recession asset allocation, since the price collapse of equities would have shifted your AA to fixed income.
Thanks. Interesting info. I am a little surprised his Equal Withdrawals beat Rebalancing. The CAPE Median was a sure winner. Definitely something to think about. While I have heard plenty of Total Return/Rebalancers, Dividend investors and some Bucket investors, I can't say I recall hearing anyone on this forum implementing the CAPE Median withdrawal method. Would be curious to hear from any of them if they are out there??
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Old 05-18-2018, 01:29 PM   #13
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So perhaps I am too much of a simpleton. I am no CAPE expert, but I looked up the current median, 16.15, and the current ratio, 32.28. Further, the CAPE ratio has been above 16 since 2010 which would be screaming sell stocks only for the last 7 years while stocks continued to run. It appears in this 7 yr scenario one would have missed some potential gains if they did not rebalance unless your rebalance had you selling 100% equities?? What am I missing here?? Also, many of us are more diverse in our equity portfolio which includes small/growth/dividend/foreign, etc. holdings whereby I don't believe the CAPE would apply?? I suppose it works if your whole equity portion is in S&P 500, but question how you apply this approach across a diverse equity portfolio?
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Old 05-18-2018, 01:54 PM   #14
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Emphasis added by me.

I am afraid it isn't. For those of us with a few more years, we also lived through 73-74 Oil crisis stock market collapse. Granted my investments at that point in time did not add up to a hill of beans, but 2008-2009 was #2 for many of us.

I guess that is why I still have a very healthy fear of The Bear and what it's powerful paws can do to one's assets. That said, I don't invest if fear, rather I invest with an eye to diversification. It's nice to have more than one hiding place if The Bear comes hunting for new prey.
I guess that we'll agree to disagree.... I have been investing since the late 70s and my investments have always been a large part of my net worth... have seen many ups and downs and sideways over that 40 years... but nothing was like 2008-2009 and I think/hope it is a once in a lifetime event..
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Old 05-24-2018, 05:51 AM   #15
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So perhaps I am too much of a simpleton. I am no CAPE expert, but I looked up the current median, 16.15, and the current ratio, 32.28. Further, the CAPE ratio has been above 16 since 2010 which would be screaming sell stocks only for the last 7 years while stocks continued to run. It appears in this 7 yr scenario one would have missed some potential gains if they did not rebalance unless your rebalance had you selling 100% equities?? What am I missing here?? Also, many of us are more diverse in our equity portfolio which includes small/growth/dividend/foreign, etc. holdings whereby I don't believe the CAPE would apply?? I suppose it works if your whole equity portion is in S&P 500, but question how you apply this approach across a diverse equity portfolio?
Yes, I am quoting myself!!

I had another thought relative to my initial post as well as the introduction of this CAPE Median withdrawal method article. Taking perhaps a more conservative approach, it would seem to me that you could set up a reasonable withdrawal strategy as follows (use my 60/40 AA and 4% rule for this example)...

- $1M portfolio 60/40 AA
- Yr 1 RE (Jan 1), take out your 4% (less your projected dividends/interest which go directly to cash) and put in cash and rebalance portfolio
- If anytime during Yr 1 your equity portion's growth exceeds next yrs annual $$, pull that money immediately and put in cash bucket to fund next years $$. If this does not occur, let everything ride "as is' and rebalance at the end of the year taking next years distribution through a normal rebalance.
- Rinse and repeat.

Perhaps I am missing something here, but the thought is a "rule" like this would have you locking in next years $$ if the markets were running hot. In some ways, Cape Median-like, but more specifically driven by the value of your equities exceeding a specific $$ amount needed, as opposed to an index reading. Obviously, the equity markets could continue to run hot until the end of the year, but then again, they could also fall from their highs. It would seem a rule like this may help investors who are more nervous about strong equity run ups?

Anyone employ a strategy like this?
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Old 05-24-2018, 07:08 AM   #16
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Yes, I am quoting myself!!

I had another thought relative to my initial post as well as the introduction of this CAPE Median withdrawal method article. Taking perhaps a more conservative approach, it would seem to me that you could set up a reasonable withdrawal strategy as follows (use my 60/40 AA and 4% rule for this example)...

- $1M portfolio 60/40 AA
- Yr 1 RE (Jan 1), take out your 4% (less your projected dividends/interest which go directly to cash) and put in cash and rebalance portfolio
- If anytime during Yr 1 your equity portion's growth exceeds next yrs annual $$, pull that money immediately and put in cash bucket to fund next years $$. If this does not occur, let everything ride "as is' and rebalance at the end of the year taking next years distribution through a normal rebalance.
- Rinse and repeat.

Perhaps I am missing something here, but the thought is a "rule" like this would have you locking in next years $$ if the markets were running hot. In some ways, Cape Median-like, but more specifically driven by the value of your equities exceeding a specific $$ amount needed, as opposed to an index reading. Obviously, the equity markets could continue to run hot until the end of the year, but then again, they could also fall from their highs. It would seem a rule like this may help investors who are more nervous about strong equity run ups?

Anyone employ a strategy like this?
I'm not in RE yet, so I'm not sure what I will do exactly. Your approach seems like it is based on sound reasoning. However, there are all kinds of countervailing factors: will pulling out the extra withdrawals from the appreciated asset push you into a higher bracket in the current year or push you over the ACA subsidy cliff (if that matters)? Are you (or your spouse) the type of person that can leave cash sitting in an account without spending?

My thoughts after reading the article in Can I Retire Yet that I cited was that I would probably not try to come up with a mechanical model, but just take valuations into account when deciding where to withdraw from. Your point in an earlier post about the fact that the CAPE 10 has been above the long term median for most of the recent past is valid. To me this means that a mechanical rule is less valuable than the general point: sell your appreciated assets before selling assets that are cheap. "Appreciated" and "cheap" will not always be easy to determine, which, to me, means a mechanical rule is not likely to increase efficiency.

I would also be curious to hear if anyone has tried a mechanical rule based on asset valuations.
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Old 05-24-2018, 08:43 AM   #17
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I do some small AA variation based on CAPE10, mainly as a way to keep myself invested when the stock market seems at an extreme overvaluation like now, and to get a little more aggressive if the stock market sells off big.

But I don’t use any long term historical average. CAPE10 has rarely dropped below 20 in my investing lifetime. I use 18 to 25 as my bounds and ramp from a 60/40 to a 50/50 AA. 55/45 is “neutral” at the mid-point of CAPE10 21.5 - so I guess I’m using that as my “median”.

It’s a minor tweak - mostly psychological.
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Old 05-24-2018, 09:20 AM   #18
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I do some small AA variation based on CAPE10, mainly as a way to keep myself invested when the stock market seems at an extreme overvaluation like now, and to get a little more aggressive if the stock market sells off big.

But I don’t use any long term historical average. CAPE10 has rarely dropped below 20 in my investing lifetime. I use 18 to 25 as my bounds and ramp from a 60/40 to a 50/50 AA. 55/45 is “neutral” at the mid-point of CAPE10 21.5 - so I guess I’m using that as my “median”.

It’s a minor tweak - mostly psychological.
Thanks. That sounds like what I will probably do when I get to my withdrawal phase.
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Old 05-24-2018, 09:30 AM   #19
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I stopped working full time in early 2007. Our asset allocation has varied from about 90/10 at that point, to 70/30 a few months later, to about 60/40 currently.

Points I want to make:

We have not bothered to have any cash around.

We didn't do buckets.

We don't rebalance based on a calendar date, but we do rebalance when our asset allocation moves too far from about 60/40.

We don't believe in "buckets", "mental accounting", "'safe' money", "peace of mind", nor "sleep well at night" crap.

Backtesting does not capture the rebalancing that we have done because most programs used for backtesting miss the best times to rebalance. They usually have only month-end prices and certainly do not use intraday prices. Some days an intraday price is 3% or more different than a closing price for the day. I believe those volatile days are opportunities that no spreadsheet nor online calculator is going to cover. Also note that one doesn't have to be perfect with al this. Nor does one need to hit every opportunity. But I think most years the once a year would underperform what we do.
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Old 05-24-2018, 09:43 AM   #20
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Thanks. That sounds like what I will probably do when I get to my withdrawal phase.
I think I did something like look at the graph since around 94, and cut of the extremes blips on either side to cone up with my “limits”. The the “neutral” point is simple the average of the limits. But if you look at the graphs we’ve spent most of the time since 1994 above 21.
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