ER & Gloom and Doom forecasts

[heyyou]

When I read about the importance of non-negative portfolio returns for the first part of retirement, I wonder about the length of that period for an ER. How long is the Critical Asset Preservation Period (CrAPP) for ERs? Don't have a source, but it seems to be common knowledge that there is a critical early period, so how long is it?
Joe

 

[perinova]

It probably much depends if you retire with the minimum required 25 times of expenses or not, as well as the market return during those early years.

IMHO you are out of the critical period when your withdrawl is below 3% of current value. (I take this number because statistically I assume that a typical portfolio can easily take up to a -25% hit).

If your portfolio increases 7% per year and take about 4% each year you should reach this level in about 7.5 years = log(1.25)/log(1.03).
But again this discounts personal inflation so this is only a minimum value....

By the way if you delay taking the 4% per year this level is reached in 3.3 years of additional work = log(1.25)/log(1.07).

 

[youbet]

it seems to be common knowledge that there is a critical early period, so how long is it?

Joe,........it depends how deep the losses during the early years are. The ultimate extreme example......you lose everything you have the first day you are retired. No matter how well the markets do after that, you're screwed. Big gains on zero = no gains.

Go to Firecalc, do some runs and observe the graph that shows ending portfolio value for each starting year. You'll quickly see that the variation is large. The low or negative values are from periods that began with negative returns.

 

[brewer12345]

Note that spiking inflation is at least as bad as lousy returns. The killer of the 1966 retirees was more inflation than low returns.

But there are good ways to reduce your risk. Add a healthy portion of TIPS to your FI allocation. Add a modest allocation of commodities. If you are really worried about some kind of equity market catastrophe, buy some modestly out of the money index puts for the first few years.

Having said that, if you are staying within the 4% WR, you are probably worried about the proverbial meteorite strike.

 

[youbet]

Note that spiking inflation is at least as bad as lousy returns. The killer of the 1966 retirees was more inflation than low returns.

Brewer.........we found something on which we can agree! Personally, I am equally concerned with inflation and returns and your comment is right on.

 

[heyyou]

Thanks for the replies. We are living on just the no-COLA pension since it pays more than our pre-retirement expenses. With retiree health insurance and no debt, our rural lifestyle just doesn't cost much compared to urban, coastal areas. True retirement begins when we start portfolio withdrawals to help the pension. That is the source of the question about how long the critical asset preservation period is, I intend to out-wait that period if I can pin a number on it. I too expect to see high inflation following a costly war, deja vu.

 

[perinova]

I hope the FED will be smart enough to control inflation with interest rate manipulation. (Even though the average worker out there would be better off with higher inflation and low interest rate...)

Would TIPS be better than a Total-Bond mutual fund? Why?
Is there TIPS mutual funds?

 

[FIRE'd@51]

IMHO you are out of the critical period when your withdrawl is below 3% of current value. (I take this number because statistically I assume that a typical portfolio can easily take up to a -25% hit).

If your portfolio increases 7% per year and take about 4% each year you should reach this level in about 7.5 years = log(1.25)/log(1.03).

Wouldn't it be log(1.33)/log(1.03) = 9.6 years, since 4 is 3% of 133, not 125

 

[modlair]

Re: Inflation spike after a war

That was the beginning of OPEC's arrival on the world scene and its choice to use oil as a instrument of influence. It was also pre Alaska oil.

History repeats when all conditions point the same direction. Don't think they do this time.

There are a lot of folks that like to expect extremes. I think there is a tendency for people not to predict something boring because boredom is not exciting. But boring things are probably the most economically likely -- meaning a continuation of capitalism and global growth and average S&P advances of 8ish% for as far as the eye can see.

 

[brewer12345]

I hope the FED will be smart enough to control inflation with interest rate manipulation. (Even though the average worker out there would be better off with higher inflation and low interest rate...)

Would TIPS be better than a Total-Bond mutual fund? Why?
Is there TIPS mutual funds?

Hmmm, I think I would prefer not to simply rely on the Fed. Anyone ding so from the mid-1960s on for about 20 years got their clock cleaned.

You make a trade off when you swap nominal bonds for TIPS. You lock in a real yield and gain inflation protection, but you lose out if the economy cools. I think the smartest thing to do is split the difference. Put some of your bond allocation in a bond index fund, and some in TIPS. You can hold TIPS directly, or buy a fund. There are various TIPS mutual funds, or there is TIP, and ETF.

 

[tryan]

There is no crappy period of ER.

 

[perinova]

Wouldn't it be log(1.33)/log(1.03) = 9.6 years, since 4 is 3% of 133, not 125

Agreed. Technically yes. 1.33=1/.75 is the real breaking point. And that would be 9.6 years.
I am trying to find not too "gloom and doom" numbers.

 

[Cut-Throat]

It probably much depends if you retire with the minimum required 25 times of expenses or not, as well as the market return during those early years.

IMHO you are out of the critical period when your withdrawl is below 3% of current value. (I take this number because statistically I assume that a typical portfolio can easily take up to a -25% hit).

If your portfolio increases 7% per year and take about 4% each year you should reach this level in about 7.5 years = log(1.25)/log(1.03).
But again this discounts personal inflation so this is only a minimum value....

By the way if you delay taking the 4% per year this level is reached in 3.3 years of additional work = log(1.25)/log(1.07).

Can you explain in detail these formulas to me. I excelled in Algebra, but admit to not understanding how you arrived at yours - log - which I assume is short for logrithum?

I am guessing that at least 75%+ on this forum does not understand this?

 

[perinova]

Can you explain in detail these formulas to me. I excelled in Algebra, but admit to not understanding how you arrived at yours - log - which I assume is short for logrithum?

I am guessing that at least 75%+ on this forum does not understand this?

-25% is the worst case yearly decrease
7% is the average yearly portfolio increase
both number are already discounted by inflation

4% is drawn so 3% is the average portfolio increase.

after n average years the value of 1 dollar is (1.03)^n.
assuming that one year a catastrophic -25% occurs the value will be .75*(1.03)^n

how many years of increase will you get your dollar back? 1=.75*(1.03)^n
take the logarithm on both sides and know that
log(a*b)=log(a)+log(b) and that, log(a^n)=n*log(a), log(1)=0

n=-log(.75)/log(1.03)=9.6

you will get your result of 9.6 YEARS to recoupe your portfolio if you withdraw 4%. If you don't withdraw it would take 4.2 YEARS

you can use log, Log or Ln on any calculator or excel.

NB: Contrary to my initial post you have to use .75, which is not 1/1.25 to reach the correct value. Which explains that a 25% decrease needs to be compensated by a 33% increase!!!!
Also contrary to my initial post the average 7% and the worst case -25% are already corrected for CPI. (those are my own calculation based on historical market return and CPI since the past 100 years or so.

 

[donheff]

log(a*b)=log(a)+log(b) and that, log(a^n)=n*log(a), log(1)=0

n=-log(.75)/log(1.03)=9.6

you will get your result of 9.6 YEARS to recoupe your portfolio if you withdraw 4%. If you don't withdraw it would take 4.2 YEARS

Cut-throat: I think our problem is we were smart enough to manipulate those advanced algebra formulas in our heads but we were too lazy (or ADD in my case) to pay enough attention to retain the underlying details. At my advanced age, I find math inherently interesting but I despair at catching up on all the stuff I never bothered to learn. For example, logs. I vaguely remember they have something to do with orders of magnitude but I don't have a good mental model for what they are about.

Perinova: Is there a dumbies book or other simple guide to refresh us early-alzheimers sufferers so we can actually understand this stuff? If so, we can start taking it apart

PS: I don't want algebra for dumbies or something. I want a nice single book that catches me up on everything - algebra, trig, geometry, calculus and differential equations. That must exist, right :

 

[RockMiner]

FWIW, I believe Bogle has suggested that balanced portfolio returns are unlikely to average better than 6% for the next several years...not much better than risk free CD's. This is based on his assesment of current valuations.

For newly minted ER's, one wonders whether this small risk premium justifies significant equity exposure, given the imperitive of avoiding big portfolio hits in the early years of retirement. I'm not advocating this (dirty market timing) approach, but I think it is a legitimate question.

Is preserving upside potential more important than limiting downside risk during the early years of ER?

 

[Cut-Throat]

FWIW, I believe Bogle has suggested that balanced portfolio returns are unlikely to average better than 6% for the next several years...not much better than risk free CD's. This is based on his assesment of current valuations.

For newly minted ER's, one wonders whether this small risk premium justifies significant equity exposure, given the imperitive of avoiding big portfolio hits in the early years of retirement. I'm not advocating this (dirty market timing) approach, but I think it is a legitimate question.

Is preserving upside potential more important than limiting downside risk during the early years of ER?

The problem of course is that Stock valuations could soar next year and get overvalued ever more and then stagnate for another 7 years or more. No one can time the market successfullly for the long haul. Not even Ho*us.

 

[Nords]

For newly minted ER's, one wonders whether this small risk premium justifies significant equity exposure, given the imperitive of avoiding big portfolio hits in the early years of retirement. I'm not advocating this (dirty market timing) approach, but I think it is a legitimate question.

Newly minted ERs have a lot more to worry about with decades of inflation than they do about losses during the first few years.

The possibility of losses during the first few years can be avoided by carrying a cash stash of 3-4 years into the start of ER and then reducing that cash to a comfort level. The volatility of the remaining high-equity portfolio doesn't cause problems if you don't have to sell. When the recovery comes then replenish the cash stash. If the recovery still hasn't come then sell what assets have lost the least, or continue the belt-tightening, or accept a higher SWR for a couple years in the expectation of a lower one in the future.

It's a lot harder to recover when a portfolio loses out to inflation year after year while we're consuming the principal. Otherwise we'd all be retired on the income from our TIPS portfolios!

 

[perinova]

Perinova: Is there a dumbies book or other simple guide to refresh us early-alzheimers sufferers so we can actually understand this stuff? If so, we can start taking it apart

PS: I don't want algebra for dumbies or something. I want a nice single book that catches me up on everything - algebra, trig, geometry, calculus and differential equations. That must exist, right :

Hmmm... I haven't seen/looked for such a book. I'd have to get back to you later on that one.

 

[RockMiner]

Newly minted ERs have a lot more to worry about with decades of inflation than they do about losses during the first few years.

Perhaps, but time and again I see early market crashes identified as the primary cause of busted retirements (based on the worst periods defined by FireCalc). I understand that these crashes may be unlikely events, whereas inflation is a given.

My post adressed the idea of risk management only during the vulnerable early years...not for the duration of ones retirement.

If FireCalc accepted time variant asset allocations we could test this concept, instead of just speculating

 

[jeff2006]

Expenses fall as we age, or so they say. If this is true, it would help counterbalance the effects of inflation long term.

 

[haha]

...we could test this concept, instead of just speculating

Killjoy!

 

[wabmester]

Is preserving upside potential more important than limiting downside risk during the early years of ER?

Limiting downside risk is what enabled me to retire (reduced my equity holdings to about 10% in late 1999), so I will always have a soft-spot in my heart for market timing.

There's nothing wrong with varying your allocation based on fundamentals or macroeconomic conditions. Most of the studies that tell you that market timing is bad are based on the idea of getting completely out of the stock market and missing a lot of upside.

For example, there's the famous Towneley study that shows that most market returns are concentrated in fairly short growth spurts, so you don't want to miss those spurts.

But the big question is what do you use for "signals" to vary your allocation? P/E values are pretty reasonable right now, for example.

Here are some suggestions from a federal reserve economist:

Market Timing Strategies That Worked

 

[bosco]

personally, I think the unconditional bias on this board against market timing is mostly reflexive and not well-thought-out.

Market timing is often undertaken to preserve capital and reduce risk, not to improve returns. I think the best investment plan is the one that matches the temprament of the investor--that is one that the investor is likely to stick with. Assuming it's a well thought-out plan, that is.

I've always been interested in timing but no longer attempt to practice it--although I wish I had been in 2000-2003, even if it would have meant getting out early. It doesn't work for me. I use an approach that is easy for me to stay on-track with.

There are well-thought out timing plans that don't make outrageous claims. For example,

http://www.mojena.com/

I don't use it, but I find it interesting. It doesn't outperform the market by much, if any. But it does reduce fluctuations. Sometimes it's wrong and whipsaws the investor. Fancy that!

besides, all this rebalancing and reallocation that goes on here isn't very much different than market timing.

 

[Cut-Throat]

I've always been interested in timing but no longer attempt to practice it--although I wish I had been in 2000-2003, even if it would have meant getting out early.

I like it! - This would be kind of like backdating stockoptions. We could call it Hindsight Timing.