I Don’t Want to Wait, But..

You have read I Don’t Want to Wait. You like what it says. But you have found what you think is a fatal flaw. It is optimistic. It requires P/E10 = 8.7. Maybe, that is too optimistic.

How about P/E10 = 12? Would that be too optimistic? P/E10 was below 12 in 1986, fourteen years before the peak of the bubble in 2000. Isn’t it reasonable to hope for P/E10 = 12 or lower within the next decade? Maybe, you won’t get the super bargain that P/E10 = 8.7 would give you. You will still be able to retire in comfort.

How about P/E10 = 16 or 18? Historically, the typical P/E10 level has been 14 to 15. Even a pessimist has to relent at some point.

From: Safe Withdrawal Rates with Switching

We can take the formulas from Safe Withdrawal Rates with Switching and see what happens when P/E10 = 10 and P/E10 = 12.
Safe Withdrawal Rates with Switching

With Switching

Assuming that you can buy 2% TIPS: if you switch portfolio allocations in accordance with P/E10, the formula for the Calculated Rate is: y = 0.3276x+3.9729 and the confidence limits are plus 1.3% and minus 0.7%.

If P/E10 = 10 and 100E10/P = 10%, the Calculated Rate is 7.25%. The confidence limits are 6.5% and 8.5%.

If P/E10 = 12 and 100E10/P = 8.33%, the Calculated Rate is 6.70%. The confidence limits are 6.0% and 8.0%.

With HSWR50T2

Assuming that you can buy 2% TIPS: if you maintain a portfolio allocation of 50% in stocks and 50% in TIPS, the formula for the Calculated Rate is: y = 0.4031x+2.9478 and the confidence limits are plus 1.5% and minus 0.8%.

If P/E10 = 10 and 100E10/P = 10%, the Calculated Rate is 6.98%. The confidence limits are 6.2% and 8.5%.

If P/E10 = 12 and 100E10/P = 8.33%, the Calculated Rate is 6.30%. The confidence limits are 5.5% and 7.8%.

With HSWR80T2

Assuming that you can buy 2% TIPS: if you maintain a portfolio allocation of 80% in stocks and 20% in TIPS, the formula for the Calculated Rate is: y = 0.6758x+1.7538 and the confidence limits are plus 2.0% and minus 1.1%.

If P/E10 = 10 and 100E10/P = 10%, the Calculated Rate is 8.51%. The confidence limits are 7.4% and 10.5%.

If P/E10 = 12 and 100E10/P = 8.33%, the Calculated Rate is 7.39%. The confidence limits are 6.3% and 9.4%.

Applying these Rates

When P/E10 = 12, switching has a 30-year Safe Withdrawal Rate of 6.0%.
When P/E10 = 10, HSWR50T2 has a 30-year Safe Withdrawal Rate of 6.2%.
When P/E10 = 12, HSWR80T2 has a 30-year Safe Withdrawal Rate of 6.3%.

At a 6.0% withdrawal rate (as with switching when P/E10 = 12 or lower), you can get a 30-year income stream of $40K per year from an initial balance of $667K. At a 6.2% withdrawal rate (as with HSWR50T2 when P/E10 = 10 or lower), you can get a 30-year income stream of $40K per year from an initial balance of $645K. At a 6.3% withdrawal rate (as with HSWR80T2 when P/E10 = 12 or lower), you can get a 30-year income stream of $40K per year from an initial balance of $635K.

Compare these numbers with what happens with P/E10 = 8.7. With P/E10 = 8.7, you would need to have $477K to $572K (plus inflation) ten years from now. Your income stream would be $40K (plus inflation) per year for at least 30 years.

It takes $95K to $158K more if P/E10 drops to 10 or 12 instead of 8.7. We do not need anything close to $1.0 million (total).

Suppose You Decide to Wait

If you have $521K to $547K today, you will not have to wait any more than ten years.

If you invest in 2% TIPS for 10 years while waiting for favorable valuations, your portfolio will grow by a factor of 1.02^10 = 1.219. Your minimum starting balances decrease by this factor.

If you wait for 10 years while investing in 2% TIPS:
1) you need an initial balance of $547K with switching if P/E10 = 12 or lower to produce an income stream of $40K per year for 30 years with a high degree of safety,
2) you need an initial balance of $529K with HSWR50T2 if P/E10 = 10 or lower to produce an income stream of $40K per year for 30 years with a high degree of safety,
3) you need an initial balance of $521K with HSWR80T2 if P/E10 = 12 or lower to produce an income stream of $40K per year for 30 years with a high degree of safety.

For the Pessimist

It is unreasonable to expect P/E10 to remain above 16 to 18 throughout the next decade. Such levels are close to bubble levels (of P/E10 = 20 or more). But it can be helpful to know what happens. Even normal investors are interested. They need to know how big a cushion makes sense.

When P/E10 = 16, switching has a 30-year Safe Withdrawal Rate of 5.3%.
When P/E10 = 16, HSWR50T2 has a 30-year Safe Withdrawal Rate of 4.7%.
When P/E10 = 16, HSWR80T2 has a 30-year Safe Withdrawal Rate of 4.9%.

When P/E10 = 16, switching has a 30-year Calculated Rate of 6.02% and a High Risk Rate of 7.3%.
When P/E10 = 16, HSWR50T2 has a 30-year Calculated Rate of 5.47% and a High Risk Rate of 7.0%.
When P/E10 = 16, HSWR80T2 has a 30-year Calculated Rate of 5.98% and a High Risk Rate of 8.0%.

When P/E10 = 18, switching has a 30-year Safe Withdrawal Rate of 5.1%.
When P/E10 = 18, HSWR50T2 has a 30-year Safe Withdrawal Rate of 4.4%.
When P/E10 = 18, HSWR80T2 has a 30-year Safe Withdrawal Rate of 4.4%.

When P/E10 = 18, switching has a 30-year Calculated Rate of 5.79% and a High Risk Rate of 7.1%.
When P/E10 = 18, HSWR50T2 has a 30-year Calculated Rate of 5.19% and a High Risk Rate of 6.7%.
When P/E10 = 18, HSWR80T2 has a 30-year Calculated Rate of 5.51% and a High Risk Rate of 7.5%.

At these levels, switching is the best choice.

To produce an income stream of $40K per year for 30 years from switching at a high degree of safety, you need an initial balance of $755K with P/E10 = 16 and $784K with P/E10 = 18.

If you wait for 10 years while investing in 2% TIPS, these numbers decrease by a factor of 1.219. You need an initial balance of $619K with P/E10 = 16 and $643K with P/E10 = 18.

All Numbers Scale

Remember that all of these numbers scale.

For P/E10 = 10 to 12

If you have a relatively modest $260K and if you decide to wait ten years, you can look forward to receiving an annual income stream of $20K (plus inflation). This makes an excellent supplement to social security and/or pension income.

If you start with the traditionally analyzed $1.0 million and if you decide to wait, your income will be almost twice as much as originally calculated, $77K (plus inflation). It is $80K per year if you start with $1.04 million.

For P/E10 = 16 to 18

You can look forward to receiving an annual income stream of $20K (plus inflation) if you start with $315K.

You can look forward to receiving an annual income stream of $80K (plus inflation) if you start with $1.26 million. You can look forward to an annual income stream of $63K (plus inflation) if you start with $1.0 million.

Have fun.

John Walter Russell
September 4, 2005