More Fun with the Toy

My new toy is the Bull Bear Retirement Trainer B. I revisited run 3 from my earlier study.

I had succeeded in withdrawing $45000 (plus inflation) each year for 30 years with an initial balance of $1000000. I ended up with a balance of $841922 (plus inflation).

[More precisely, $841922 is the initial balance in Year 30. It includes investment returns from Year 29. NOTE: sequences start with Year 0.]

This time, using an identical sequence of returns, I approximated fixed allocations of 50% and 80% stocks. The 50% stock portfolio succeeded. It had a final balance of $142949 (plus inflation).

Using the same sequence of returns, the 80% stock portfolio ran out of money after 28 years. The initial balance at Year 28 was $30366. It was not enough to cover the $45000 withdrawal.

To keep everything in perspective: with a fixed 50% stock allocation (rebalanced annually), the Likely Success rate is 4.43%. With a fixed 80% stock allocation (rebalanced annually), the Likely Success rate is 4.21%. The Almost Certain Failure rate is 5.99%.

Run 3 is a typical sequence of returns, starting from today’s valuations. It is a little bit lucky.

Playing with the Toy

Run 3 Returns

I generated Run 3 based on today’s valuations, P/E10=27.3 and today’s TIPS interest rate of 2.2%. I assumed that we are in a secular Bear Market.

Here is the list of annual returns for Run 3. This is what appeared in cells C16 through C46 in Bull Bear Retirement Trainer B.

[Bull Bear Retirement Trainer B requires a Copy and Paste Special (Values) process from cells B16:B46 to C16:C46 to fix the sequence of returns. Otherwise, the returns would change at all steps along the way, eliminating the effect of Mean Reversion. I do not have the tools to automate this part of the process.]

0.09594
0.07566
0.08522
(0.09772)
0.34701
(0.31358)
(0.21626)
(0.00710)
(0.04534)
0.01334
0.35250
(0.34532)
0.17352
0.14659
0.50859
0.10911
0.04127
0.07277
(0.28947)
0.21759
0.28255
(0.27048)
0.00256
0.29020
0.27872
0.18183
(0.05782)
0.29344
(0.33056)
0.43940
0.19205

80% Stocks

For my first new version of run 3, I started with $1000000 with 80% in stocks: that is, $800000 in stocks and $200000 in TIPS. I did not maintain a stock allocation of EXACTLY 80%, but I came close.

I withdrew $36000 from stocks ($45000 total) each year from Years 0 through 6. P/E10 peaked at the beginning of Year 5 at 30.5. The total balance peaked at the beginning of Year 5 as well. It was $1172053. Year 6 started with P/E10=19.6 and a balance of $829317. The stock allocation had briefly expanded to 85%, but was now back down to 80%.

Year 7 began with P/E10=14.4. The balance was down to $652962. This was 55.7% of the peak from two years earlier. But it was still 65.3% of the initial balance. There had still been 7 withdrawals, totaling $315000.

It was a bad downward fluctuation, but hardly unexpected.

I started rebalancing the portfolio in Year 7 by withdrawing the entire $45000 from the TIPS account. This turned out to be sufficient until Year 12. I withdrew $36000 from stocks in Years 8 through 11.

The portfolio stabilized, but drifted downward. At the beginning of Year 12, it hit bottom. P/E10 had fallen to 8.8. The balance was $391960, which is 39.2% of the initial balance and 33.4% of the peak.

Stocks had taken a beating. At Year 12 I withdrew $20000 from stocks and $25000 from TIPS. At Year 13, I withdrew the standard $36000 from stocks. At Year 14, stocks had recovered enough for me to withdraw $45000 from stocks. At Year 15, I was able to withdraw $70000 from stocks, which added $25000 to the TIPS balance.

[Remember: withdrawals totaled $45000 each year. Normally, 80% of this or $36000 would come from stocks and $9000 would come from TIPS.]

At the beginning of Year 15, stocks had recovered enough that the balance rose back to $497566. P/E10 was 14.7. I had already withdrawn 15 times for a total of $675000.

I rebalanced in Year 18 by withdrawing $50000 from stocks. In Year 19, I withdrew $10000. In Year 20, I withdrew $50000. After that, allocations stabilized. Only in Year 25 did I have to withdraw something other than the standard $36000 amount. In Year 25, I withdrew $45000 from stocks.

At the beginning of Year 18, P/E10=14.9 and the balance was $447816. At the beginning of Year 19, P/E10=9.9 and the balance was $311929, a decline of $135887 or 30.3%.

The market recovered. At the beginning of Year 21, P/E10=13.6 and the balance was $332284. But it fell again. At the beginning of Year 23, P/E10=8.7 and the portfolio balance was only $179759, from which it never recovered.

At the beginning of Year 28, P/E10=14.9 and the balance was $30366.

50% Stocks

For my second new try at run 3, I started with $1000000 with 50% in stocks: that is, $500000 in stocks and $500000 in TIPS. I did not maintain a stock allocation of EXACTLY 50%, but I came close.

I withdrew $22500 from stocks ($45000 total) each year from Years 0 through 4. When P/E10 peaked at the beginning of Year 5 at 30.5, the total balance was $1060528 and I withdrew $115000 from stocks (which added $70000 to TIPS) to restore the balance.

After that, I found myself rebalancing like crazy. Seldom did I simply withdraw $22500 from stocks. In the real world, this could be expensive. I actually had to sell stocks five times to rebalance. I had to go beyond the standard withdrawal amount of $45000.

At the beginning of Year 7, P/E10=14.4 and the portfolio balance was $743011 in contrast to $652962 with 80% stocks.

When the market hit bottom in Year 12, P/E10=8.8 the portfolio balance was $531133 in contrast to $391960 with 80% stocks.

At the beginning of Year 15, P/E10=14.7 and the portfolio balance was $611176. The 80% stock portfolio had recovered strongly. But it was still lower. Its balance was $497566.

The portfolio did well. It never experienced breathtaking highs or lows. But it did last an entire 30 years. At the beginning of Year 30, it had a balance of $142949.

A Lesson in Contrasts

The 80% stock portfolio experienced big swings. But it was in a secular (long lasting) Bear Market. It gave up more than it gained. It did not do as well as a TIPS-only baseline portfolio.

With a TIPS-only portfolio, you would have ended up with $37000 after 30 years.

[Use section 1 of Compact CVTVR N to do this calculation. In Step 1, set the number of years N at 30.0 in cell C7. Choose to use a special interest rate initially (enter 1 into cell F8). Specify a special interest rate of 2.2% in cell D9. Specify the withdrawal rate during the first N years as 4.5% in cell E14. Read the percentage remaining after N years in cell E15 (3.7%).]

The 50% stock portfolio involved hyperactive portfolio rebalancing. But it did the job. It survived a secular (long lasting) Bear Market. It did better than a TIPS-only baseline portfolio. It had a final balance of $142949.

I found my original approach much easier. I either withdrew nothing from stocks or transferred large dollar amounts from my TIPS account into stocks during the first 15 years. During Year 16, after stocks had done spectacularly well, I restored my TIPS transfers. I treaded water, withdrawing $20000 each year from Year 17 through 21. I made a large transfer of funds back into stocks in Year 22 when valuations were attractive once more. Stocks did spectacularly well once again, beginning in Year 23. I replenished the TIPS account in Year 27. I entered Year 30 with a balance of $841922.

In essence, a straightforward approach of paying attention to prices and betting on bargains paid off. It was much easier. It was much more profitable.

An Assessment of Four Approaches

We are in the earlier years of a long lasting (secular) Bear Market. Valuations are sky high, even now. The immediate outlook for stocks is not encouraging. Today’s retirees face a challenge.

My original approach was best. It was similar to Latch and Hold, but without the rigid rules demanded by computers. It was very easy. It was intuitive in light of my many investigations.

In contrast, maintaining a 50% stock allocation required constant attention just to maintain percentages. It paid off, but not well. It did better than a TIPS-only portfolio.

The TIPS-only portfolio ranks number 3 out of 4. Yet, it does much better than the traditional 4.0% withdrawal rate claimed (incorrectly) by early studies. It provides $45000 annually, guaranteed, for 30 years and leaves you with a balance of $37000.

The 80% stock allocation had wide swings. But this is a Bear Market. It went down more than up. It lasted 28 years, not 30.

Dividend Strategies

I did not include a dividend strategy in this investigation. Doing so with precise numbers would be difficult.

Implementing a dividend strategy would be easy. In run 3, P/E10 at Year 12 was 8.8 as compared to 27.3 today. Dividend yields should be about 3 times as high as today’s. If you were to take advantage of Year 11 and Year 12 balances to buy high quality, high dividend paying stocks, you would do well. Your income stream would be likely to grow faster than inflation. The EXACT numbers are uncertain, but you would do very well.

Have fun.

John Walter Russell
September 2, 2006