Edited: Large Cap Growth and Switching

I started by collecting a baseline with fixed stock allocations of 0%, 30%, 50%, 70% and 100%.

Later, I made a survey. I varied the stock allocation depending upon P/E10.

The Calculator

I used my Gummy 03 version of the Deluxe Calculator V1.1A08 Revised: January 28, 2005. I weighted the stock allocation entirely to Large Cap Growth.
Gummy’s (Peter Ponzo’s) Database

Conditions

I set the starting balance at $100000. I set expenses to 0.20%. I varied the withdrawal rate. I used the CPI for inflation. I examined 30-year sequences starting in 1928-1980. There are 53 sequences. Stock allocations consisted of Large Cap Growth. I used commercial paper for my non-stock allocation. I left the beginning and end of year withdrawal allocations at 50%, the default setting.

I started by collecting a baseline with fixed stock allocations of 0%, 30%, 50%, 70% and 100%.

Later, I made a survey. I varied the stock allocation depending upon P/E10. When P/E10 was below the lower threshold (which varied), the stock allocation was 100%. When P/E10 was between the two thresholds, I used an intermediate allocation of 30% or 50% or 70% as indicated. When P/E10 exceeded the upper threshold, which I set at 21, the stock allocation was 0%.

[The best intermediate stock allocation (when there was only one intermediate allocation) from a previous survey using commercial paper was 40%. The best P/E10 thresholds were 11 and 21. Similar studies using TIPS favored a 30% allocation and P/E10 thresholds of 12 and 21.]

Procedure

I increased the withdrawal rate in increments of 0.1%. I recorded the highest rate at which all portfolios from 30-year sequences beginning in 1928-1980 survived. I have listed those rates as HSWR.

I continued increasing withdrawal rates in increments of 0.1%. I recorded the lowest withdrawal rate at which 1 or more, 5 or more and 10 or more portfolios failed.

This method allows me to survey a large number of conditions rapidly. By including data with 5 and 10 failures, I am able to spot difficulties associated with probability distributions.

Results

This was a limited survey. This was not a full optimization. This did not include a full sensitivity study.

Baselines

Calculator data:
1928-2000, 30-year sequences from 1928-1980, $100000 initial balance, 0.20% expenses.
Calculator settings:
Fixed allocations. No switching, but with annual rebalancing.
Stock Allocations: 0%, 30%, 50%, 70%, 100%.

Stock Allocation = 0%. That is, 100% commercial paper. 30-year Failures in 1928-1980:
HSWR: 2.3
First failure: 2.4
Five failures: 2.5
Ten failures: 2.6

Stock Allocation = 30%
30-year Failures in 1928-1980:
HSWR: 3.3
First failure: 3.4 in year 1937
Five failures: 3.8 in years 1936-1940
Ten failures: 4.0

Stock Allocation = 50%
30-year Failures in 1928-1980:
HSWR: 3.8
First failure: 3.9
Five failures: 4.2
Ten failures: 4.4

Stock Allocation = 70%
30-year Failures in 1928-1980:
HSWR: 3.8
First failure: 3.9
Five failures: 4.1
Ten failures: 4.4

Stock Allocation = 100%
30-year Failures in 1928-1980:
HSWR: 3.4
First failure: 3.5 in year 1966, 1968
Five failures: 3.6 in years 1929, 1966, 1968-1969, 1973
Ten failures: 4.1

The Survey of Thresholds and Allocations

Calculator data:
1928-2000, 30-year sequences from 1928-1980, $100000 initial balance, 0.20% expenses.
Calculator settings:
P/E10 thresholds: varies-21-24-80.
Allocations: 100-varies-0-0-0.

It was necessary to collect a full set of data with P/E10 thresholds of 9-15.
..

Survey Results

Our best conditions are with P/E10 thresholds of 12 and 13. A threshold of 11 is also good.

Most conditions favor a 30% stock allocation.

There is an interaction.

Conditions with P/E10 thresholds of 12 and 13 favor a stock allocation of 30% although 50% is also good. At a threshold of 11, it is arguable as to whether 30% or 50% is better. At P/E10 thresholds below 11, the data favor higher allocations.

The best condition has a 30% stock allocation and a lower P/E10 threshold of 13. [The upper P/E10 threshold has been held constant at 21.]

Comparisons

These are the best results with a fixed allocation.

Stock Allocation = 50%
30-year Failures in 1928-1980:
HSWR: 3.8
First failure: 3.9
Five failures: 4.2
Ten failures: 4.4

These are the best results with switching.

P/E10 threshold = 13 and Allocation =30%
30-year Failures in 1928-1980:
HSWR: 5.1
First failure: 5.2
Five failures: 5.4
Ten failures: 5.4

S&P500 Comparisons

A comparison with comparable S&P500 data from an earlier sanity check is enlightening.

The best S&P500 Historical Surviving Withdrawal Rates with a fixed allocation were better than those with Large Cap Growth:

Stock Allocation = 70%
30-year Failures in 1928-1980:
HSWR: 4.1
First failure: 4.2
Five failures: 4.4
Ten failures: 4.8

The best S&P500 condition with switching was:

P/E10 threshold = 12 or 13 and Allocation = 30%
30-year Failures in 1928-1980:
HSWR: 5.3
First failure: 5.4
Five failures: 5.6
Ten failures: 5.7

Summary

The S&P500 did better than Large Cap Growth.

The best allocations and thresholds for the S&P500 and Large Cap Growth were similar.

Large Cap Growth responded well to switching according to the P/E10 of the S&P500. It increased the Historical Surviving Withdrawal Rates at all levels of failure by 1.0% or more.

Caution: I have not made any adjustments for today’s valuations. The actual results starting with today’s valuations are unlikely to be as good. You can still estimate relative performance when compared to the S&P500 index.

Observation

Large Cap Growth is an example of how diversification can harm a portfolio. Large Cap Growth is an underperformer. Including it along with the other elements of the S&P500 has brought the Historical Surviving Withdrawal Rates of the S&P500 down for retirements from 1928-1980. However, it is possible that Large Cap Growth has helped the S&P500 in other periods.

Have fun.

John Walter Russell
From February 1, 2005