Tonight I have irrigation scheduled. My times to switch the valves so that I get my grove watered are at 1:00 AM to 2:00 AM. So I have time on my hands. . .
A couple of years ago I was looking at the effect on SWR and on average terminal value of using TIPS and I-bonds vs commercial paper. The results made me a convert on TIPS and I-bonds. Recently, I revisited these simulations and figured out that I still like TIPS and I-bonds, but not quite as much as I did originally. If you are a glutton for tabulated punishment, you might find this interesting. It's a lot easier to understand with graphs, but I don't know how to do that on these boards.
30 year SWR Simulations: It's interesting what TIPS and I-bonds (as opposed to commercial paper) do for the SWR and terminal value expectations. I used the following assumptions with intrcst's SWR 6.1 simulator:
(1) January values for the S&P500
(2) 50% of the annual withdrawal taken at the beginning of the year, 50% at year end.
(3) inflation indexed to the CPI.
(4) fixed income series: 1st case based on 4-6 month commercial paper -- 2nd case based on TIPS @ 2% -- 3rd case based on I-bonds @ 2%.
(4) 0.20% annual expense ratio
(5) portfolio rebalanced annually
(6) Stated maximum safe withdrawal rate is that which creates a terminal value of $1 at the end of 30 years.
SWR: I ran the 30 year simulations to find SWR and average terminal value. TIPS and I-bonds dramatically affect the results of the simulations for lower stock allocation percentages. The maximum SWR is obtained at much lower stock allocation values when TIPS or I-bonds are used. In particular, maximum SWR for the commercial paper case is 4.12% with a stock allocation of 60%. For the TIPS case, the SWR increases to 4.3% with a stock allocation of 30%. And the I-bond simulations resulted in a SWR of 4.32% with a stock allocation of 25%. See table below for abreviated data summary.
Stock ---------max SWR----------
Alloc. TIPS comm paper I-bnd
100 3.74% 3.74% 3.74%
90 3.87% 3.85% 3.87%
80 3.98% 3.95% 3.98%
70 4.07% 4.04% 4.07%
60 4.16% 4.12% 4.16%
50 4.22% 3.91% 4.21%
40 4.28% 3.64% 4.28%
30 4.30% 3.35% 4.31%
20 4.10% 3.05% 4.31%
10 3.89% 2.70% 4.29%
Average Terminal Value: Average terminal value increased monotonically with increasing stock allocation for all three cases. I've tabulated the inflation adjusted terminal values as a multiple of the initial balance in the table below. TIPS and I-bonds reduce the average terminal values for stock allocations of 50% or less. In fact, the average terminal values become alarmingly low in order at stock allocation levels that achieve "optimum" SWR. If you are looking only at SWR, you might be missing another kind of risk to the portfolio because overall balances become so low.
Stock ----ave terminal value----
Alloc. TIPS comm paper I-bnd
100 3.208 3.208 3.208
90 2.671 2.641 2.744
80 2.176 2.246 2.362
70 1.763 1.861 1.979
60 1.372 1.53 1.669
50 1.042 1.422 1.377
40 0.751 1.356 1.089
30 0.51 1.299 0.848
20 0.407 1.248 0.658
10 0.316 1.215 0.484
Terminal Values with equivalent Withdrawal Rates: Part of the effect noted above (ie. reduction of average terminal value using TIPS and I-bonds) is due to the use of increased SWR for these cases. So I re-ran the simulations capping the SWR for the TIPS simulations at the maximum SWR for commercial paper. (I leave the I-bond simulation for someone else). The TIPS case still results in a reduction of terminal value, but not as significantly.
Stock -----SWR----- -ave terminal value-
Alloc. TIPS comm paper TIPS comm paper
100 3.74% 3.74% 3.208 3.208
90 3.87% 3.85% 2.671 2.641
80 3.98% 3.95% 2.176 2.246
70 4.12% 4.04% 1.763 1.861
60 4.12% 4.12% 1.400 1.53
50 4.12% 3.91% 1.110 1.422
40 4.12% 3.64% 0.850 1.356
30 4.30% 3.35% 0.600 1.299
20 4.10% 3.05% 0.407 1.248
Summary: So for all three bond types, there is a tradeoff between maximizing safe withdrawal rate (SWR) and increasing your odds of experiencing portfolio growth that outstrips inflation (thereby increasing your SWR). Use of TIPS or I-bonds increases SWR over commercial paper, but only by moving the optimum stock allocation to values that reduce odds of large portfolio growth. If you use TIPS or I-bonds with equivalent stock allocations, you make marginal increases in SWR with small reductions in average terminal value.
A couple of years ago I was looking at the effect on SWR and on average terminal value of using TIPS and I-bonds vs commercial paper. The results made me a convert on TIPS and I-bonds. Recently, I revisited these simulations and figured out that I still like TIPS and I-bonds, but not quite as much as I did originally. If you are a glutton for tabulated punishment, you might find this interesting. It's a lot easier to understand with graphs, but I don't know how to do that on these boards.
30 year SWR Simulations: It's interesting what TIPS and I-bonds (as opposed to commercial paper) do for the SWR and terminal value expectations. I used the following assumptions with intrcst's SWR 6.1 simulator:
(1) January values for the S&P500
(2) 50% of the annual withdrawal taken at the beginning of the year, 50% at year end.
(3) inflation indexed to the CPI.
(4) fixed income series: 1st case based on 4-6 month commercial paper -- 2nd case based on TIPS @ 2% -- 3rd case based on I-bonds @ 2%.
(4) 0.20% annual expense ratio
(5) portfolio rebalanced annually
(6) Stated maximum safe withdrawal rate is that which creates a terminal value of $1 at the end of 30 years.
SWR: I ran the 30 year simulations to find SWR and average terminal value. TIPS and I-bonds dramatically affect the results of the simulations for lower stock allocation percentages. The maximum SWR is obtained at much lower stock allocation values when TIPS or I-bonds are used. In particular, maximum SWR for the commercial paper case is 4.12% with a stock allocation of 60%. For the TIPS case, the SWR increases to 4.3% with a stock allocation of 30%. And the I-bond simulations resulted in a SWR of 4.32% with a stock allocation of 25%. See table below for abreviated data summary.
Stock ---------max SWR----------
Alloc. TIPS comm paper I-bnd
100 3.74% 3.74% 3.74%
90 3.87% 3.85% 3.87%
80 3.98% 3.95% 3.98%
70 4.07% 4.04% 4.07%
60 4.16% 4.12% 4.16%
50 4.22% 3.91% 4.21%
40 4.28% 3.64% 4.28%
30 4.30% 3.35% 4.31%
20 4.10% 3.05% 4.31%
10 3.89% 2.70% 4.29%
Average Terminal Value: Average terminal value increased monotonically with increasing stock allocation for all three cases. I've tabulated the inflation adjusted terminal values as a multiple of the initial balance in the table below. TIPS and I-bonds reduce the average terminal values for stock allocations of 50% or less. In fact, the average terminal values become alarmingly low in order at stock allocation levels that achieve "optimum" SWR. If you are looking only at SWR, you might be missing another kind of risk to the portfolio because overall balances become so low.
Stock ----ave terminal value----
Alloc. TIPS comm paper I-bnd
100 3.208 3.208 3.208
90 2.671 2.641 2.744
80 2.176 2.246 2.362
70 1.763 1.861 1.979
60 1.372 1.53 1.669
50 1.042 1.422 1.377
40 0.751 1.356 1.089
30 0.51 1.299 0.848
20 0.407 1.248 0.658
10 0.316 1.215 0.484
Terminal Values with equivalent Withdrawal Rates: Part of the effect noted above (ie. reduction of average terminal value using TIPS and I-bonds) is due to the use of increased SWR for these cases. So I re-ran the simulations capping the SWR for the TIPS simulations at the maximum SWR for commercial paper. (I leave the I-bond simulation for someone else). The TIPS case still results in a reduction of terminal value, but not as significantly.
Stock -----SWR----- -ave terminal value-
Alloc. TIPS comm paper TIPS comm paper
100 3.74% 3.74% 3.208 3.208
90 3.87% 3.85% 2.671 2.641
80 3.98% 3.95% 2.176 2.246
70 4.12% 4.04% 1.763 1.861
60 4.12% 4.12% 1.400 1.53
50 4.12% 3.91% 1.110 1.422
40 4.12% 3.64% 0.850 1.356
30 4.30% 3.35% 0.600 1.299
20 4.10% 3.05% 0.407 1.248
Summary: So for all three bond types, there is a tradeoff between maximizing safe withdrawal rate (SWR) and increasing your odds of experiencing portfolio growth that outstrips inflation (thereby increasing your SWR). Use of TIPS or I-bonds increases SWR over commercial paper, but only by moving the optimum stock allocation to values that reduce odds of large portfolio growth. If you use TIPS or I-bonds with equivalent stock allocations, you make marginal increases in SWR with small reductions in average terminal value.