Changing the Threshold
I have collected more data on the Scenario Surfer. This time, I changed the threshold for Dollar Cost Averaging from P/E10=20 to P/E10=14.
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 14.0 and higher. Previously, I had set the threshold at P/E10=20.
I sought to eliminate conditions in which I lost money compared to investing in TIPS alone.
When P/E10=20, the odds of a loss ten years into the future is around 20%. The upside potential is a 20% chance of exceeding 6% (plus inflation). When P/E10=14, the odds of a loss ten years into the future is around 5%. The most likely return is about 6% (plus inflation).]
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: 7.1K
50% stocks: 8.2K
80% stocks: 9.4K
Run: 2
Varying allocations: 6.2K
20% stocks: 6.3K
50% stocks: 5.9K
80% stocks: 5.5K
Run: 3
Varying allocations: 6.4K
20% stocks: 6.5K
50% stocks: 6.7K
80% stocks: 6.8K
Run: 4
Varying allocations: 6.4K
20% stocks: 6.5K
50% stocks: 6.7K
80% stocks: 6.8K
Run: 5
Varying allocations: 6.4K
20% stocks: 6.5K
50% stocks: 6.6K
80% stocks: 6.8K
Year 10. P/E10=26 Bear Market
Run: 1
Varying allocations: 12.4K
20% stocks: 12.7K
50% stocks: 13.0K
80% stocks: 13.1K
Run: 2
Varying allocations: 15.6K
20% stocks: 12.9K
50% stocks: 13.5K
80% stocks: 13.9K
Run: 3
Varying allocations: 12.4K
20% stocks: 13.7K
50% stocks: 15.7K
80% stocks: 17.8K
Run: 4
Varying allocations: 13.1K
20% stocks: 12.3K
50% stocks: 11.8K
80% stocks: 11.0K
Run: 5
Varying allocations: 9.6K
20% stocks: 11.4K
50% stocks: 10.0K
80% stocks: 8.7K
Year 15. P/E10=26 Bear Market
Run: 1
Varying allocations: 19.0K
20% stocks: 19.9K
50% stocks: 20.9K
80% stocks: 21.1K
Run: 2
Varying allocations: 43.6K
20% stocks: 22.2K
50% stocks: 27.4K
80% stocks: 32.9K
Run: 3
Varying allocations: 19.0K
20% stocks: 21.5K
50% stocks: 25.3K
80% stocks: 29.0K
Run: 4
Varying allocations: 20.4K
20% stocks: 17.3K
50% stocks: 14.1K
80% stocks: 10.5K
Run: 5
Varying allocations: 18.9K
20% stocks: 18.7K
50% stocks: 18.0K
80% stocks: 17.3K
Year 20. P/E10=26 Bear Market
Run: 1
Varying allocations: 27.9K
20% stocks: 26.1K
50% stocks: 25.2K
80% stocks: 23.4K
Run: 2
Varying allocations: 76.7K
20% stocks: 31.1K
50% stocks: 39.2K
80% stocks: 48.1K
Run: 3
Varying allocations: 26.3K
20% stocks: 30.0K
50% stocks: 35.1K
80% stocks: 40.6K
Run: 4
Varying allocations: 54.4K
20% stocks: 28.1K
50% stocks: 29.3K
80% stocks: 28.1K
Run: 5
Varying allocations: 63.4K
20% stocks: 31.5K
50% stocks: 40.3K
80% stocks: 50.1K
In run 1, P/E10 fell below 14 first in Year 19. In run 2, P/E10 fell below 14 in Year 1. P/E10 never fell below 14 in run 3. In runs 4 and 5, P/E10 fell below 14 by Year 10.
Falling Behind
It was still possible for the balance to fall behind contributions. This happened at Year 10 in run 5.
Year 20 Outcomes
All Year 20 outcomes were satisfactory with the new P/E10=14 threshold. The worst case was run 3. You would not have purchased any stocks at all. But the Year 20 value of P/E10 was 17.9. I looked at the Year 30 SWR (button on the left). You would able to withdraw 5.0% safely using Switching B (95% chance of success).
This was the highest Year 20 value of P/E10. Run 5 had a Year 20 P/E10 value of 16.2, but it had a very high balance ($63.4K). At Year 20, the other runs ended with very attractive levels of P/E10 and very high Safe Withdrawal Rates.
Conclusions
The lower threshold worked well. It was still possible to be behind contributions at Year 10. It was possible to reach Year 20 without ever entering the stock market. The Year 20 balances were all satisfactory. In three out of five cases, the Year 20 balances were spectacular.
This is only my first investigation into alternative thresholds. Using P/E10=14 occasionally locks you out of stocks for extended periods of time. Most likely, good alternatives exist.
Have fun.
John Walter Russell
October 25, 2007
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