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How do you know when to buy?
I view stocks as being comprised of two very different elements. They are in part pieces of paper reflecting ownership in a business enterprise. They are in part gambling chips.
The part that reflects business enterprises is fairly predictable. This is not so if you are looking at a single stock because the underlying business might do extremely well or extremely poorly. But when you are looking at an index, you have good, bad, and medium businesses all mixed in. It's a reasonably safe bet to assume that U.S. businesses will produce profits in the future somewhat in the way they have in the past.
What about the gambling part? That is the part that causes prices to rise dramatically in bull markets and to fall dramactically in bear markets. This part is highly unpredictable in the short term, but largely predictable in the long term. In the long term, stocks can't go down, down, down forever or up, up, up forever. They ultimately must come to reflect the value of the underlying businesses. Things can get stretched to the extreme in either direction, but ultimately they must snap back.
My aim is to buy stocks when their values are such that the long-term payoff is high enough to provide an income stream strong enough to support my Retire Early plan. You don't need to wait until valuations are at the exact medium level. At a medium level, stocks are a highly attractive asset class, so they can be attractive enough even at valuations higher than medium level. There comes a time, however, when valuations are so high that this asset class cannot reasonably be expected to provide the long-term financial support needed for your plan to work.
And the bigger question - What if you're wrong?
Is the payoff to the house from a slot machine predictable? Not in the short-term. If you are talking about 10 pulls of the lever, the house can lose. But the house can hardly lose if you are talking about 10 million pulls of the lever. The odds favor the house and over time the house is going to win.
The same is true of the investor who takes valuation levels into account in purchasing stocks. He is going to "win" in the long term. The part that is uncertain is when. If it takes 40 years for him to win, and he dies after 35, that's not much of a win in a real-world sense.
What SWR analysis tells you is how long it will take to win in the event that stocks perform in the future as they have in the past. It is of course possible that they will not. If stocks do something that they have never done before, the numbers generated by an SWR analysis do not apply. SWR analysis is always rooted in the assumption that the future will be something like the past.
My question is--If you are not going to base your planning on an assumptuion that stocks will perform in the future somewhat in the way in which they have performed in the past, what the heck are you going to base it on? I can't come up with any other guidepost that makes better sense than SWR analysis.
That said, I think it makes perfect sense in the application phase to adjust the numbers to reflect personal taste. An optimist might want to go with a number higher than the number generated by an SWR analysis, and a pessimist might want to go with something lower.
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