Early Success with Latch and Hold

I recently built Latch and Hold Calculator LH02. It tells us what happens to Historical Surviving Withdrawal Rates if we extend the crossing of a valuation (P/E10) threshold by a fixed number of years.

I looked at 30-Year Historical Surviving Withdrawal Rates. At the Historical Surviving Withdrawal Rate, the balance at year 30 is zero or positive. Increasing the withdrawal rate by 0.1% causes the balance to become negative.

I adjusted all withdrawals to match inflation. The withdrawal rate is a percentage of the initial portfolio balance (plus inflation).

Latch and Hold dramatically improves the upside of (stock allocation) switching when starting in times of typical and bargain level valuations. Latch and Hold retains the substantial advantage of switching over fixed allocations in times of high valuations.

Settings

I set the upper threshold to P/E10 = 24.1 with an extension of 4 years. This causes the calculator to act as if P/E10 were equal to 24.1 until four years after it falls below 24.1. I set the lower threshold to P/E10 = 8, which is a bargain level, with an extension of 7 years. I set the calculator to prefer the lower threshold results in the event of a conflict.

Except for this pre-processing of P/E10, the calculator is identical to the standard Deluxe V1.1A08a version. Pre-processing affects only what happens with switching (i.e., varying stock allocations in accordance with P/E10).

Otherwise, I used the settings of SwOptT2. SwOptT2 consists of stocks (S&P500) and TIPS at a 2% (real) interest rate. It sets the P/E10 thresholds at 9-12-21-24 with stock allocations of 100%-50%-30%-20%-0%, respectively. I refer to this combination of Latch and Hold thresholds and SwOptT2 settings as LHOptA.

I also collected baseline data. I used the SwOptT2 settings. I set the upper threshold equal to 100. I set the lower threshold equal to 1. These values removed the effects of the Latch and Hold algorithms.

LHOptA was the best condition from my initial Latched Threshold Survey. SwOptT2 is the best (stock allocation) switching algorithm in the absence of a memory (that is, without latch and hold).

Regression Equations

Here are the LHOptA regression equations of 1923-1980 30-Year Historical Surviving Withdrawal Rates versus the percentage earnings yield 100E10/P.

y = 0.5584x+2.7896 plus 3.0% and minus 1.2%.
R squared = 0.5469.

Special note: On the upside, there are two distributions. The higher limit is plus 3.0%. The more common, inner condition has a limit of plus 0.8%. As an approximation: the confidence levels start out as plus and minus 1.2%. The upside splits, with some conditions reaching considerably higher rates. The improvement on the upside, when the results are on the upside, is dramatic whenever the earnings yield is more than 7.5%.

Here are the SwOptT2 regression equations of 1923-1980 30-Year Historical Surviving Withdrawal Rates versus the percentage earnings yield 100E10/P.

y = 0.3626x+3.7678 plus and minus 0.8%.
R squared = 0.6835.

Data Analysis

Lowest 30-Year Historical Surviving Withdrawal Rates (1923-1980):

LHOptA: 5.2% in 1959.
SwOptT2: 5.2% in 1959, 1960, 1961, 1962, 1964 and 1965.
Fixed 80% stocks: 3.9% in 1966.
Fixed 50% stocks: 3.9% in 1937.

Highest 30-Year Historical Surviving Withdrawal Rates (1923-1980):

LHOptA: 12.9% in 1924 (and 13.3% in 1922).
SwOptT2: 9.2% in 1924 and 1933 (and 10.1% in 1921 and 1922).
Fixed 80% stocks: 10.3% in 1950.
Fixed 50% stocks: 7.8% in 1980 (and 8.1% in 1921).

At today’s valuation level (P/E10 = 27):

LHOptA:
Safe Withdrawal Rate (95% probability of success, one sided): 3.7%.
Coin Toss Rate (50%-50%): 4.86%.
High Risk Rate (5% probability of success, one sided): 7.9%.

SwOptT2:
Safe Withdrawal Rate (95% probability of success, one sided): 4.3%.
Coin Toss Rate (50%-50%): 5.11%.
High Risk Rate (5% probability of success, one sided): 5.9%.

At a typical valuation level (P/E10 = 14):

LHOptA:
Safe Withdrawal Rate (95% probability of success, one sided): 5.6%.
Coin Toss Rate (50%-50%): 6.78%.
High Risk Rate (5% probability of success, one sided): 9.8%.

SwOptT2:
Safe Withdrawal Rate (95% probability of success, one sided): 5.6%.
Coin Toss Rate (50%-50%): 6.36%.
High Risk Rate (5% probability of success, one sided): 7.2%.

At a bargain valuation level (P/E10 = 8):

LHOptA:
Safe Withdrawal Rate (95% probability of success, one sided): 8.6%.
Coin Toss Rate (50%-50%): 9.77%.
High Risk Rate (5% probability of success, one sided): 12.8%.

SwOptT2:
Safe Withdrawal Rate (95% probability of success, one sided): 7.5%.
Coin Toss Rate (50%-50%): 8.30%.
High Risk Rate (5% probability of success, one sided): 9.1%.

Special note about Historical Surviving Withdrawal Rates:

There was only a single year in which LHOptA underperformed SwOptT2. It was 1929 with a Historical Surviving Withdrawal Rate of 5.9% as opposed to 6.6%. P/E10 was 27.0, the highest level prior to the mid-1990s.

There were several years in which fixed allocations did better than switching.

The most dramatic advantage of LHOptA occurred in the early 1920s when P/E10 was unusually low.

Summary

My research had previously shown that switching (stock allocations) is superior when starting from times of high valuations, but not when starting at times of normal and bargain level valuations. Latch and Hold has already recovered the upside.

Have fun.

John Walter Russell
June 10, 2006