More about Withdrawing 5% Safely at P/E10=20

Prices are high. You cannot withdraw 5% of your original balance (plus inflation) safely with a traditional fixed allocation strategy. You can with Valuation Informed Indexing.

Previously, I examined what happens in a long lasting (secular) bear market. We are in such a market today. This time, I looked at what happens in a normal market.

Background

The traditional approach used in Safe Withdrawal Rate studies sells stock shares as necessary with a stock/bond (S&P500/TIPS) portfolio. You rebalance your portfolio each year to maintain a fixed stock allocation. Your withdrawal rate is the original amount withdrawn divided by the original portfolio balance. You increase withdrawals to match inflation.

With Valuation Informed Indexing, you vary allocations in accordance with valuations as measured by Professor Robert Shiller’s P/E10.

I treated the non-stock portion of my investments as equivalent to 3% TIPS. I believe that this is reasonable based on the traditional spread of corporate bonds and preferred shares above treasury securities.

Year 30 SWR Retirement Risk Evaluator

I set P/E10=20, TIPS interest rate=3.0% and the Year 30 final amount of 0%. These are the results:

Safe Withdrawal Rate
20% stocks with rebalancing: 4.68%.
50% stocks with rebalancing: 4.56%.
80% stocks with rebalancing: 3.83%.
100% stocks: 3.30%.

Likely Success Rate (50%-50%)
20% stocks with rebalancing: 5.08%.
50% stocks with rebalancing: 5.26%.
80% stocks with rebalancing: 5.23%.
100% stocks: 5.10%.

Almost Certain Failure Rate
20% stocks with rebalancing: 5.68%.
50% stocks with rebalancing: 6.16%.
80% stocks with rebalancing: 6.83%.
100% stocks: 7.10%.

This shows that reaching a 5% (plus inflation) withdrawal rate is a coin toss (close to 50%-50%) when P/E10=20.

Scenario Surfer Runs

I invested entirely in stocks and TIPS. I started with a $100000 balance. I selected P/E10=20 Normal Market. I withdrew $5500 (plus inflation) each year. I set the TIPS interest rate to 3.0%. Here are the Year 30 balances. I have included fixed allocation results for comparison.

Run 1. 21,073.
20% rebalanced: bankrupt in year 29.
50% rebalanced: 23,418.
80% rebalanced: 59,282.

Run 2. 11,352.
20% rebalanced: bankrupt in year 27.
50% rebalanced: bankrupt in year 28.
80% rebalanced: bankrupt in year 25.

Run 3. 92,390.
20% rebalanced: bankrupt in year 29.
50% rebalanced: 34,709.
80% rebalanced: 54,047.

Run 4. bankrupt in year 24.
20% rebalanced: bankrupt in year 26.
50% rebalanced: bankrupt in year 25.
80% rebalanced: bankrupt in year 24.

Run 5. 81,534.
20% rebalanced: bankrupt in year 30.
50% rebalanced: 31,449.
80% rebalanced: 52,490.

I reduced my withdrawal amount to $5000 (plus inflation) each year.

Run 1. 238,525.
20% rebalanced: 22,552.
50% rebalanced: 69,803.
80% rebalanced: 109,663.

Run 2. 112,308.
20% rebalanced: 20,569.
50% rebalanced: 47,558.
80% rebalanced: 58,160.

Run 3. 290,830.
20% rebalanced: 35,406.
50% rebalanced: 93,565.
80% rebalanced: 132,121.

Run 4. 70,446.
20% rebalanced: 15,673.
50% rebalanced: 39,343.
80% rebalanced: 48,502.

Run 5. 144,221.
20% rebalanced: 10,044.
50% rebalanced: 20,174.
80% rebalanced: 15,780.

Summary

Once again, Valuation Informed Indexing allows you to withdraw 5% (plus inflation) when P/E10=20. A normal market helped somewhat. It was not enough to lift the Safe Withdrawal Rate to 5.5% (plus inflation).

In a normal market, using fixed allocations at a 5% (plus inflation) withdrawal rate survived 5 times out of 5. The odds of success in a normal market appear to be better than a coin toss (50%-50%).

Have fun.

John Walter Russell
July 30, 2008