Learning the RIGHT LessonsI continue to play with my Simplified Retirement Trainer A. Most recently, following my earlier Accumulation and the Retirement Trainer study, I have made a series of practice runs with Dollar Cost Averaging starting from a balance of $0. I have placed them into my Yahoo Briefcase. You can download Accumulation Summary A from my Retirement Trainers folder. Initial Glimpse at the DataHere are the Year 30 Balances. They provide us our first look. We can learn some early lessons even at this stage.Annual investments: $5000 total, each year, starting from $0. Year 30 Balances Dollar Cost Averaging entirely into TIPS In all cases: $213923 Dollar Cost Averaging into 100% Stocks a1 $497218 a2 $796149 a3 $565313 a4 $470566 a5 $502360 a6 $736770 a7 $353582 a8 $389387 Dollar Cost Averaging with Variable Allocations First try. a1 $628085 a2 $916362 a3 $566726 a4 $489726 a5 $750677 a6 $480086 a7 $481236 a8 $443426 Second Try. 2a1 $554007 2a2 $797604 2a3 $601564 2a4 $492845 2a5 $678519 2a6 $379180 2a7 $436950 2a8 $432117 Third Try: Systematic with 21 and 14. a1 $536461 a2 $837906 a3 $728859 a4 $491976 a5 $868711 a6 $213923 a7 $321790 a8 $460544 Fourth Try. 14 and 20 and 20%. a1 $579908 a2 $793306 a3 $650031 a4 $506965 a5 $743496 a6 $388067 a7 $448642 a8 $431860 Fifth Try. 14 and 20 and load up on stocks early. a1 $526090 a2 $797640 a3 $627657 a4 $489726 a5 $705783 a6 $488248 a7 $571636 a8 $421390 Initial ObservationsStaying out of stocks entirely produced the worst outcome at Year 30.Investing in stocks-alone produced two sub par conditions, with balances below $400000. In terms of minimum balances, the first and the fifth try produced the best results. The second try showed that it was possible for me to lose ground. In the third try, I tried to introduce a mechanical process. I used the 20% and 80% (inner) confidence limits in a Bear Market to define two P/E10 levels: 14 and 21. I intended to buy at the lower P/E10 level and sell at the higher, a form of latch-and-hold. The P/E10=14 level turned out to be a disaster. It kept me out of stocks entirely in run 3a6 (third try, run a6). I tried to correct this on the fourth try by setting a 20% lower stock allocation goal. In addition, I changed the levels to P/E10=14+ (actually, 14.9) and 20. This helped, but it did not bring the run 4a6 (fourth try, run a6) balance above $400000. Changing from a numerical 20% goal to a less specific “load up on stocks early” instruction brought up all Year 30 balances above $400000. In some ways, my first try was still the best. It did not come with clear instructions. To put matters into context, run a6 is out of the ordinary. The secular Bear Market low always stays above historically typical levels. It never falls below P/E10=15. Initial ConclusionsWe should invest in stocks some of the time, but not necessarily all of the time.We should pay attention to valuations. We need to be careful to avoid rules that depend on these particular runs. Having an unusual run (a6) helps us keep our balance. It is not sufficient to acknowledge that we have a chance of getting blindsided. We need to be able to handle a special situation. Year 10 and Year 20 BalancesAnnual investments: $5000 total, each year, starting from $0.Year 10 Balances Dollar Cost Averaging entirely into TIPS In all cases: $56467 Dollar Cost Averaging into 100% Stocks a1 $80640 a2 $49754 a3 $38565 a4 $68810 a5 $35944 a6 $81950 a7 $65690 a8 $47310 Dollar Cost Averaging with Variable Allocations First try. a1 $91337 a2 $51947 a3 $52109 a4 $74595 a5 $50197 a6 $78285 a7 $72062 a8 $55675 Second Try. 2a1 $79082 2a2 $51947 2a3 $55996 2a4 $73810 2a5 $50751 2a6 $69882 2a7 $66284 2a8 $58579 Third Try: Systematic with 21 and 14. a1 $56467 a2 $59589 a3 $61021 a4 $75659 a5 $56467 a6 $56467 a7 $56467 a8 $60640 Fourth Try. 14 and 20 and 20%. a1 $70956 a2 $53904 a3 $55996 a4 $73810 a5 $49416 a6 $65698 a7 $63102 a8 $54735 Fifth Try. 14 and 20 and load up on stocks early. a1 $86785 a2 $52675 a3 $46233 a4 $74595 a5 $43957 a6 $78555 a7 $69611 a8 $53319 Year 20 Balances Dollar Cost Averaging entirely into TIPS In all cases: $126663 Dollar Cost Averaging into 100% Stocks a1 $151967 a2 $190451 a3 $118820 a4 $131344 a5 $352747 a6 $219802 a7 $192344 a8 $225353 Dollar Cost Averaging with Variable Allocations First try. a1 $202201 a2 $195227 a3 $139894 a4 $138286 a5 $400498 a6 $199781 a7 $248133 a8 $245830 Second Try. 2a1 $174810 2a2 $195227 2a3 $145463 2a4 $141882 2a5 $416090 2a6 $175778 2a7 $224140 2a8 $242932 Third Try: Systematic with 21 and 14. a1 $168866 a2 $168866 a3 $154890 a4 $139594 a5 $448812 a6 $126663 a7 $210390 a8 $257325 Fourth Try. 14 and 20 and 20%. a1 $184295 a2 $196808 a3 $145613 a4 $145202 a5 $415711 a6 $166849 a7 $225014 a8 $237151 Fifth Try. 14 and 20 and load up on stocks early. a1 $164590 a2 $196233 a3 $130628 a4 $138286 a5 $371277 a6 $208979 a7 $286405 a8 $239830 Observations from Years 10 and 20With TIPS-only, your balance at Year 10 would be $56467. Dollar cost averaging into an all-stock portfolio produced two balances out of eight that were below $40000. The balance for run a3 was $38565. For run a5, it was $35944.This draws our attention to a huge problem. How do you stay with an approach in the face of a decade of losses? Even if you make it through the first decade, you may have difficulty making it through the second. There are still two cases out of eight with disappointing performance (runs a3 and a4). Looking carefully at the other conditions, when balances were low at Years 10 and 20, P/E10 levels were also low. Dividend yields would be more than twice as high as they are today. A retiree might be dissatisfied with his balance, but he would not be disappointed with his income. The RIGHT LessonsHere are the RIGHT lessons when dollar cost averaging over a long period of time:1) You should invest in stocks at least part of the time. 2) You should NOT automatically invest into stocks ALL of the time. 3) You should seek to invest more into stocks early. 4) You should pay attention to valuations. Worthy of special emphasis: 5) If you pay attention to valuations and if your balance has not grown as much as you would like, it will be because valuations are low, dividends are high and future prospects are outstanding. Have fun. John Walter Russell September 22, 2006 |