January 2009 Stock Allocations

P/E10 has fallen back into the normal range. This is a time for high stock allocations.

The Reality Checker

The Reality Checker will automate many functions of the Scenario Surfer. It summarizes the outcomes of 100 runs for the same set of inputs.

I ran a series of runs using a prototype of the Reality Checker. I assumed an initial balance of $100000. I withdrew $5000 plus inflation each year. I used 2% TIPS for the holding other than stocks. The stock performance is representative of the S&P500.

Results

I brought up the prototype of the Reality Checker. I compared fixed allocations of 70-80-90-100% for today’s P/E10=14 Bear Market. The results were similar but favored 80% at Year 15.

I brought up the prototype of the Reality Checker. I compared fixed allocations of 70-80-90-100% for a P/E10=14 Normal Market. The results were similar but favored 100% at Year 15. There was no difference on the downside, but there was a big difference on the upside.

I brought up the Year 15 SWR Retirement Risk Evaluator. With a final balance of zero and P/E10=14, it favored an allocation of 30% to 40%. With a final balance of 50% of the original balance (plus inflation), it favored an allocation of 100%.

Changes are gradual. Outcomes are not extremely sensitive to stock allocations.

Remarks

Today’s stock allocation should be high.

We are currently in a long lasting (secular) Bear Market. Spotting the turning point when the Bear Market ends is difficult at best.

The data favor high stock allocations. However, it makes sense to have some cash on hand in case the market becomes even more attractive.

The market is highly likely to drop another 20% to a P/E10 level below 11. The market could easily drop another 50% to a P/E10 level below 8. This would be well within historical norms.

For those with a neutral market outlook, a current stock allocation of 80% is a good choice.

For pessimists: a stock allocation as low as 60% makes sense. They will want to buy heavily when prices come close to a bottom. They should, of course, ease into larger stock allocations over the next few years. They need to protect themselves in case they are wrong.

Have fun.

John Walter Russell
October 10, 2009