August 9, 2007 Letters to the Editor

Updated: August 21, 2007.

TIPS

I received this from Scott.

What does TIPS stand for?

HERE IS MY RESPONSE

Thank you.

They are a special form of Treasury bonds. TIPS stands for Treasury Inflation Protected Securities. At one time, such bonds were officially known as Treasury Inflation Indexed Securities.

I recently updated an earlier Letter to the Editor about TIPS and Ibonds. It includes helpful links to Treasury Direct.

June 5, 2005 Letter to the Editor

IRA Rollover Safe Withdrawal Rates

I received this from Bob.

Good Morning John:

All the articles I have read on SWR [Safe Withdrawal Rate] relate to funds accumulated in taxable accounts. In the future more folks will be withdrawing from tax sheltered accounts as I am doing (age 73 with a Vanguard IRA Rollover of about one million). As you know the percentages are fixed and increase each year. About the only strategy I can employ is to use part of each withdrawal to re-purchase funds in my taxable account. Have you written (or know of anyone who has) about how people should plan for and execute a viable strategy in these circumstances? For what its worth, after taking out 15% for income taxes I'm investing another 15% of the withdrawal in two funds on a fifty/fifty basis (Balance Index and High Yield Tax Exempt. Have no idea how this is going to work out in the long run or how my wife will have to deal with it once I'm gone (she's 69). Your comments would be appreciated.

Thanks.

HERE IS MY RESPONSE

You are exceedingly kind.

I believe that you are referring mainly to my recent dividend studies, which look really good.

Most traditional Safe Withdrawal Rate studies assume tax sheltered accounts, mainly because including taxes is difficult. It is very difficult to come up with something meaningful except on a case by case basis. They, as I, have simply acted as if taxes didn’t matter. More precisely, they have assumed no taxes during accumulation and applied taxes to all withdrawals.

I have seen many articles suggesting a “best” approach. I have seen many discussion board comments that show that the “best” approach depends on many assumptions beyond any individual’s control.

You have a good approach for two reasons: it is easy to remember what to do each year and it makes sense. Highly complex rules work well only if subtle assumptions pan out. Your approach takes taxes into account but avoids the trap of letting taxes dominate your investments.

By focusing on something simple, you are likely to make GOOD decisions even if your faculties degrade over the years. This is much, much better than depending upon a complex, optimal solution. Nor do I expect you to be caught by any obscure changes in the tax law.

One Market, Three Different Textbooks and Sage Advice

I received this from Rob Bennett.

This is in response to your article "One Market, Three Different Textbooks and Sage Advice."

As you know, I too have been testing out the Investor's Scenario Surfer in preparation for its public release in September or October. I very much agree with the observations you are putting forward in this article.

In working the calculator, one needs to decide in advance on the precise goal of the project. If you are trying to get the best possible results, extreme positions (0 percent stocks at very high valuations, 100 percent stocks at very low valuations) work well. If you are trying to generate a returns pattern that you could live with in the real world, you probably want to go with more moderate choices (perhaps 70 percent stocks even when 100 percent works better from a pure numbers standpoint, perhaps 30 percent stocks even when 0 percent works better from a pure numbers standpoint).

There are two important lessons for today's investor. You have commented on them in earlier articles, but these key points cannot be made often enough.

One, it is not at all hard to beat a portfolio where the stock allocation is set through rebalancing through use of a portfolio where the stock allocation is set by making reference to the valuation level that applies for that year. I have done four test runs, and have beaten all three rebalancing portfolios (20 percent, 50 percent, and 80 percent) each time. That amazes me. The more times the experience is repeated (under a variety of types of return sequences), the more confident I become that blind valuation-ignorant rebalancing strategies simply do not make sense.

Two, stocks offer an extremely poor long-term value proposition at today's valuation levels. One thing you learn through use of this calculation is that you very much want to avoid the Big Hit, the stunning loss that makes it impossible for you to catch up for many years with where you would have been had you employed a more reasonable stock allocation in the year of a big price drop. The risk of suffering a Big Hit is small to zero at most valuation levels. When you get to the sorts of valuation levels that apply today, however, they are common. It makes no sense for long-term investors to be going with high stock allocations when stocks are at the price levels that apply today, in my view (informed by what I have learned about the message of the historical stock-return data through use of this calculator).

I think this calculator is an amazing tool. I have hopes that it will help lots of people learn how to invest in more effective ways. Your statistical research is providing a huge help to all aspiring early retirees. We have truly changed the history of stock-market investing advice with the work we have done in this area, in my estimation.

That's an incredibly bold statement. But I don't see what other way there is to say it when you compare the results obtained from making valuation-informed allocation choices with those obtained from following blind valuation-ignorant rebalancing choices. The difference in results at the end of the 30-year time-period examined by the calculator is often in the millions! And I have never yet obtained a worse result from taking valuations into account (there are of course going to be cases where this happens, but it appears that those cases will very much be the exception and not the rule).

Rebalancing doesn't work! Spread the word -- Rebalancing doesn't work!

HERE IS MY RESPONSE

Thank you, Rob.

I agree. The advantage of using valuations is incredible. I routinely end up with a 4.5% continuing withdrawal rate (i.e., no loss of purchasing power at Year 30) versus balances close to zero or bankruptcy with rebalancing.

I have fallen behind only in one condition tested. That was with P/E10 starting at 8. Starting with $1.0 million, I ended up with $3.7 million at Year 30 versus $5.8 million with 80% stocks. That particular sequence had a bubble!

Rebalancing assumes that no one can measure valuations in a meaningful way. Thanks to Professor Robert Shiller’s early research, we now know better.

Here are my personal results from the checkout: Manual allocations versus rebalancing. I started with $1000000 and withdrew $45000 (plus inflation) each year. All amounts are after adjusting for inflation (i.e., real dollars).

Initial P/E10: 26
Manual: $1194491
20% Stocks: $42024
50% Stocks: $132169
80% Stocks: $110423

Initial P/E10: 32
Manual: $2063616
20% Stocks: $26403
50% Stocks: $71680
80% Stocks: -$50443

Initial P/E10: 20
Manual: $790268
20% Stocks: $69311
50% Stocks: $214055
80% Stocks: $170619

Initial P/E10: 20
Manual: $885296
20% Stocks: $54911
50% Stocks: $167659
80% Stocks: $186299

Initial P/E10: 14
Manual: $2765361
20% Stocks: $233897
50% Stocks: $715418
80% Stocks: $1180065

Initial P/E10: 14
Manual: $6042336
20% Stocks: $304533
50% Stocks: $926179
80% Stocks: $1455364

Initial P/E10: 8
Manual: $3715560
20% Stocks: $630752
50% Stocks: $2512462
80% Stocks: $5831260

Letters to the Editor in 2007

Letters to the Editor in 2006

Letters to the Editor in 2005