In A Normal Market

Today’s Bear Market allows us to withdraw 5% (plus inflation). But what about a Normal Market?

In a Normal Market, P/E10=14 as it is today, but valuations are more likely to rise than in a long lasting (secular) Bear Market.

Scenario Surfer

I examined a starting valuation of P/E10=14 (Normal Market). I started with a balance of $100000 and withdrew $5500 (plus inflation) annually. For stocks, I invested in the S&P500 index. I invested in 2% TIPS for my non-stock allocation.

Algorithm

I used Valuation Informed Indexing. In this case, I allocated 20% to stocks when P/E10=18 and above. I allocated 80% to stocks when P/E10=8 through 18. I allocated 100% to stocks when P/E10 fell below 8.

Data

I took these data using the Scenario Surfer with a P/E10=14 (Normal Market). I have included fixed allocation results for comparison.

Run 1. 183,693.
20% stocks: bankrupt in Year 27.
50% stocks: 39,017.
80% stocks: 101,167.

Run 2. 57,132.
20% stocks: bankrupt in Year 25.
50% stocks: bankrupt in Year 29.
80% stocks: 18,049.

Run 3. 49,512.
20% stocks: bankrupt in Year 27.
50% stocks: 14,908.
80% stocks: 43,528.

Run 4. 261,025.
20% stocks: bankrupt in Year 28.
50% stocks: 47,438.
80% stocks: 127,122.

Run 5. 305,176.
20% stocks: bankrupt in Year 27.
50% stocks: 48,313.
80% stocks: 162,964.

Run 6. 71,183.
20% stocks: bankrupt in Year 26.
50% stocks: 6,662.
80% stocks: 28,238.

Run 7. 134,747.
20% stocks: 554.
50% stocks: 123,153.
80% stocks: 317,359.

Run 8. 2,798.
20% stocks: bankrupt in Year 25.
50% stocks: bankrupt in Year 28.
80% stocks: bankrupt in Year 30.

Run 9. 291,612.
20% stocks: bankrupt in Year 30.
50% stocks: 89,379.
80% stocks: 194,414.

Run 10. 74,303.
20% stocks: bankrupt in Year 28.
50% stocks: 38,492.
80% stocks: 94,155.

Data Summary

These runs reflected a variety of possibilities. This includes a narrow trading range, bargain prices and even a bubble. Valuation Informed Indexing handled them all.

In 8 out of 10 runs, Valuation Informed Indexing produced the highest final balance. In two runs, an 80% fixed stock allocation had the highest final balance. In all instances, Valuation Informed Indexing produced a positive balance at Year 30.

The 80% fixed allocation went bankrupt by Year 30 in 1 out of 10 runs.

The 50% fixed allocation went bankrupt by Year 30 in 2 out of 10 runs.

The 20% fixed allocation went bankrupt by Year 30 in 9 out of 10 runs.

Conclusions

This Valuation Informed Indexing algorithm allows you to withdraw 5.5% of your original balance (plus adjustments to match inflation) with a high level of safety in a Normal Market. It is better than using a fixed allocation.

Have fun.

John Walter Russell
December 11, 2008