Overcoming the Fixed Income Fixation

[intercst]

Here's an interesting article from a newsletter that Vanguard sends to its Flagship clients.


http://flagship5.vanguard.com/VGApp...ALL_assets_ALL.html&Season2=Summer&Year2=2004

intercst

 

[Hyperborea]

Quite interesting how there was little difference in the worst cases no matter what the withdrawal rate up until 4%. Either the standard 4% or the group home 2% gave roughly the same result except for the sacrifices over the 25 years. Well, other than for those with a high percentage of fixed income and in that case you come pretty close to failure at 4%. It makes sense that somebody with 100% fixed income would be pushing a 2% withdrawal rate.

Hmmm, this just occurred to me but the roughly 4% withdrawal appears to have some of the properties of a phase transition at least for worst case withdrawals.

 

[cute fuzzy bunny]

"Results were calculated in 43 different scenarios based on actual market performance with different starting dates. In the calculations, stock returns were represented by the Standard & Poor's 500 Index (1960-1970) and the Dow Jones Wilshire 5000 Composite Index (1971-2003). Bond returns were represented by the S&P High Grade Corporate Bond Index (1960-1968 ), the Citigroup High Grade Bond Index (1969-1972), and the Lehman Brothers U.S. Government/Credit Bond Index (1973-2003)."

Anyone want to speculate on why they changed indexes over these time periods when perfectly adequate stock and bond indexes spanned the full period they measured?

I'm sure theres a reason, I just cant imagine what it is...

 

[intercst]

"Results were calculated in 43 different scenarios based on actual market performance with different starting dates. In the calculations, stock returns were represented by the Standard & Poor's 500 Index (1960-1970) and the Dow Jones Wilshire 5000 Composite Index (1971-2003). Bond returns were represented by the S&P High Grade Corporate Bond Index (1960-1968 ), the Citigroup High Grade Bond Index (1969-1972), and the Lehman Brothers U.S. Government/Credit Bond Index (1973-2003)."

Anyone want to speculate on why they changed indexes over these time periods when perfectly adequate stock and bond indexes spanned the full period they measured?

I'm sure theres a reason, I just cant imagine what it is...

That's strange to me, too. There's a very high correlation between the S&P500 and the Wilshire 5000, so the results would be about the same no matter which index you used.

Perhaps the reasoning is that the Wilshire 5000 offers some additional diversification, so once that index became available in 1971 they switched to it.

intercst

 

[hocus]

Thanks for posting the link, intercst.

 

[cute fuzzy bunny]

Yeah the S&P and wilshire arent too far apart...so why not just use the s&p throughout?

The weirder one was the bond indexes...a corp bond index followed by a blended index followed by a government heavy index.

 

[wabmester]

Geez, I often complain that you can't draw conclusions from FIREcalc because there are so few independent sequences to evaluate.

These guys restricted themselves to 1960-2003, which means that every one of their 43 "scenarios" had overlap. So, apparently the moral of their story is that stocks will do fine as long as we have a repeat of the longest bull run in history.

 

[cute fuzzy bunny]

Well there's that too, but I didnt want to sound too cynical.

On the other hand, its got the benefit of the sampling periods to be in modern times with modern financial situations.

The 43 periods arent relevant though, and I dont know why people keep missing this. The only relevant period is the worst one. If you cant make it through that one, good luck. There'll be another just like it, sooner or later.

 

[Hyperborea]

The 43 periods arent relevant though, and I dont know why people keep missing this.  The only relevant period is the worst one.  If you cant make it through that one, good luck.  There'll be another just like it, sooner or later.

Actually that time period includes one of the "worst ones" and depending on allocation maybe the "worst one". Portfolios starting in the mid to late 60's have to make it through the terrible market returns of the '70's compounded with high inflation. If you run Firecalc (or similar) that is often the break point for many portfolios.

 

[wabmester]

its got the benefit of the sampling periods to be in modern times with modern financial situations.

I'm not interested in results from modern times;  I want a good simulation of future times  

Which period in history corresponds to the time in which we had a global economy with seemless transactions across borders, we were at war with an enemy with decentralized control, and we had the technology to clone humans and make nanotech machines?

In any case, to make matters worse, the 43 years they looked at only had 18 complete 25-year sequences.   Are they including all of the bogus short runs in their results?

 

[wabmester]

Portfolios starting in the mid to late 60's have to make it through the terrible market returns of the '70's compounded with high inflation.

Are you assuming they factored inflation into their results? Here's what they say:

Amounts are in 2004 dollars and are not adjusted for inflation

Frankly, I don't even know what their statement means for sure, but I assume they simply didn't consider inflation.

 

[Hyperborea]

Are you assuming they factored inflation into their results?   Here's what they say:

Amounts are in 2004 dollars and are not adjusted for inflation

I would guess that they are meaning in the same way that Firecalc et al don't account for inflation in the final portfolio values.  The dollars haven't been reduced for inflation.  That ~$300K that's left in the portfolio after 25 years is ~$300K dollars but they are not equal to ~$300K dollars at the start of the 25 years.

 

[JWR1945]

You can set up similar conditions in FIRECalc and in the Retire Early Safe Withdrawal Calculator. Both provide you with a cleaner method of processing (none of this changing which index to use versus time), cover the entire time frame available (starting from 1871) and display all of the details.

From the fact that a 5% withdrawal rate can result in a balance of zero dollars, I conclude that the withdrawals are based upon a portfolio's initial balance.

From the fact that it takes a withdrawal rate of 5% to produce at least one balance of zero dollars, I conclude that withdrawals are not adjusted for inflation.

The worst case when withdrawals are always in nominal dollars (i.e., not adjusted for inflation) occurs in 1929 and 1930. There are many bad sequences through 1940 when withdrawals are in nominal dollars.

In terms of the 1960-2003 time frame, the worst case is determined by 1974. The 1965 turns out to be affected the most at year 10.

I recommend that viewers go to FIRECalc to set up similar conditions. See for yourself. Get the full story.

The key is selecting not to adjust withdrawals to match inflation. [Choose NONE instead of PPI or CPI.] All of FIRECalc's balances are in nominal dollars.

Have fun.

John R.

 

[sgeeeee]

I'm not interested in results from modern times;  I want a good simulation of future times  

. . .

Well, okay . . . I can do that for you, but it's going to cost you.

Here's the deal. Send me all of your money today and I will predict your financial status tomorrow.