Questions on ESRBob's Book

[bongo2]

I finally got arount to reading ESRBob's excellent book Work Less, Live More, and I have a couple questions that y'all might have figured out.

For the 4/95 method (where you withdraw the maximum of 4% of your portfolio or 95% of your previous year's withdrawal), are you limiting yourself to 95% before or after the impact of inflation? I read through that section a couple of times, and if Bob explains it then I missed it. So, what I mean is that if you spend $100 in year 1, the market tanks and inflation is 15%, then in year two do you get to spend $95 or $109 (95% of $100 after 15% inflation).

The second question that I have is one of expenses. I think that Bob's safety results for the 4/95 method are before consideration of investment expenses, and I just wanted to make sure that that was the case.

The last question that I have is the issue of data mining. Bob presents safety results for a portfolio that is sliced into many re-balanced sub accounts including some fairly exotic things like hedge funds. This, more diversified portfolio has a much better safety record than the standard 50/50 S&P/Treasuries. It seems a little optimistic to fully expect this extra safety, which has only been gained with the benefit of higndsight. If you started your retirement in 1965, then I doubt that you would have started with the knowledge that a X% allocation to hedge funds was going to be the one that pulled you through. It is interesting to see that a thinly sliced portfolio can do better, and you might believe it enough to actually slice up your portfolio in a similar way, but it seems optimistic to me to actually count on the full impact of this diversification gleaned from a time when there was much less evidence of the diversification benefit, and it was much more difficult to implement such a scheme.

 

[Ed_The_Gypsy]

My thoughts:

1) $95. The whole idea is to protect your pot from depleting too fast. Inflation is a spending problem. Eat less cat food. (Control your consumption.)

2) I am sure the withdrawals are net of expenses. You are drawing out of a pot after subtracting investment costs, because that is what is left.

3) I think I get the drift of this question. Actually, no, I don't.

If the point is that some financial vehicles were not available in 1965, true enough, but the asset classes were still there. As an asset class, the EAFE may not have existed back then (I don't know), but someone could estimate what it might have done by following a group of significant foreign stocks back in time. As a vehicle, hedge funds may not have existed or been widely available back then (or only available to a few rich suckers), true. How does one estimate how a hedge fund might have performed in the past? Good question. Personally, I am perfectly capable of losing my money on my own, I do not need someone else to help me. I won't go near a hedge fund. Nobody should, IMHO.

I think you can take ESRBob's portfolio as one possible way to acheive diversification. If you want to see other, more practical ways to make your own diversified portfolio, check out Gummy's site and look for slice-and-dice. Much of the math is beyond me, but he brings it down to earth in the end. There is a ton of stuff on his site but it is worth the trouble to go through it once you find what you want.

http://www.gummy-stuff.org/

 

[ats5g]

Hey bongo,

I find the " return data" on hedge funds to be extremely suspect because they were virtually unregulated until recently. Not only does the data suffer from survivorship bias [meaning those returns for hedge funds that have gone out of business aren't included in the data], but the data also suffers from "reporting bias" because hedge funds weren't required to report returns, so the data may be skewed upwards as those hedge funds that did horrible didn't report their returns.

Sources of Hedge Fund Returns: Alphas, Betas, and Costs

Diehard conversation on Alternative investments

In Gummy's sensible withdrawal spreadsheet you can allocate to TSM, LV, LB, SV, + SG, as well as short term, int term, and long term bonds.

- Alec