Adding a Second Threshold

There is still a lot to be learned from the Scenario Surfer. This time, I added an upper threshold for Dollar Cost Averaging.

Conditions

I dollar cost averaged for 20 years. I started with $1000 and added $1000 each year thereafter. I invested entirely in stocks when P/E10 fell below 14.0 and entirely in 2% (real interest) TIPS when P/E10 was 35.0 and higher. I allocated 20% to stocks whenever P/E10 was 14.0 and higher but still below 35.0. Previously, I had used a single threshold with a 100% or 0% stock allocation.

I sought to eliminate conditions in which I was locked out of stocks for a long period of time.

P/E10=13 or 14 is a typical condition. Today’s P/E10 is twice as high (above 28).

The Data

I looked at a P/E10=26 bear market. I took 5 runs.

Balances are at Years 5, 10, 15 and 20. I include fixed stock-TIPS allocations for purposes of comparison.

Year 5. P/E10=26 Bear Market

Run: 1
Varying allocations: 6.4K
20% stocks: 6.4K
50% stocks: 6.3K
80% stocks: 6.2K

Run: 2
Varying allocations: 7.3K
20% stocks: 7.2K
50% stocks: 8.6K
80% stocks: 10.0K

Run: 3
Varying allocations: 5.3K
20% stocks: 5.9K
50% stocks: 5.1K
80% stocks: 4.4K

Run: 4
Varying allocations: 6.7K
20% stocks: 6.7K
50% stocks: 7.0K
80% stocks: 7.3K

Run: 5
Varying allocations: 6.9K
20% stocks: 6.9K
50% stocks: 7.5K
80% stocks: 8.0K

Year 10. P/E10=26 Bear Market

Run: 1
Varying allocations: 12.4K
20% stocks: 12.4K
50% stocks: 12.3K
80% stocks: 12.1K

Run: 2
Varying allocations: 12.6K
20% stocks: 11.8K
50% stocks: 10.6K
80% stocks: 9.3K

Run: 3
Varying allocations: 20.3K
20% stocks: 13.8K
50% stocks: 16.0K
80% stocks: 18.1K

Run: 4
Varying allocations: 11.4K
20% stocks: 11.9K
50% stocks: 11.0K
80% stocks: 10.1K

Run: 5
Varying allocations: 17.2K
20% stocks: 13.0K
50% stocks: 13.5K
80% stocks: 13.7K

Year 15. P/E10=26 Bear Market

Run: 1
Varying allocations: 28.2K
20% stocks: 20.0K
50% stocks: 21.1K
80% stocks: 21.7K

Run: 2
Varying allocations: 16.9K
20% stocks: 17.4K
50% stocks: 14.8K
80% stocks: 12.2K

Run: 3
Varying allocations: 30.7K
20% stocks: 19.8K
50% stocks: 20.5K
80% stocks: 20.6K

Run: 4
Varying allocations: 23.2K
20% stocks: 19.8K
50% stocks: 20.5K
80% stocks: 20.7K

Run: 5
Varying allocations: 44.8K
20% stocks: 20.6K
50% stocks: 21.9K
80% stocks: 21.5K

Year 20. P/E10=26 Bear Market

Run: 1
Varying allocations: 42.7K
20% stocks: 29.4K
50% stocks: 34.0K
80% stocks: 38.3K

Run: 2
Varying allocations: 51.0K
20% stocks: 28.8K
50% stocks: 32.0K
80% stocks: 34.1K

Run: 3
Varying allocations: 62.1K
20% stocks: 29.9K
50% stocks: 35.1K
80% stocks: 39.5K

Run: 4
Varying allocations: 33.5K
20% stocks: 28.3K
50% stocks: 30.3K
80% stocks: 30.8K

Run: 5
Varying allocations: 81.6K
20% stocks: 29.7K
50% stocks: 33.6K
80% stocks: 35.2K

P/E10 rose above 35.0 only in run 2. It was 44.1 in Year 5.

Staying Ahead

When varying allocations, balances consistently exceeded contributions. With a high (80%) fixed stock allocation, the balance fell behind contributions twice: in Year 5 of run 3 and in Year 10 of run 2.

Conclusions

Using two thresholds worked well. All Year 20 outcomes were spectacular except for run 4, which was satisfactory.

Have fun.

John Walter Russell
October 26, 2007