Portfolio Safety Insights

I have collected tables to give you insights into the safety of your retirement portfolio. You can spot dangers early enough to respond effectively.

I looked at a variety of portfolios. I examined their balances in the early years.

I collected portfolio balances at withdrawal rates high enough to have some failures, but low enough to have many successes as well. I call a portfolio successful if it still has a positive balance after 30 years. [I selected 30 years for reasons of data reduction and analysis. It makes a good starting point.]

One set of tables shows the balances at years 5, 10, 11 and 12. The other set of tables shows the minimum balances during the first 5 years and during the first 10 years.

I looked at the years 1921-1980 and 1871-1980 separately. The more recent data tell you what is most likely to happen. Data from the earlier years give you insights as to what might happen if we encounter a surprise in the markets. Portfolios from those years behave differently from today in a variety of ways for a variety of reasons. For example, portfolios consisting entirely of commercial paper supported withdrawal rates of 6% in the late 19th century.

Portfolios

HSWR80 consists of 80% stocks (S&P500 index) and 20% commercial paper. The withdrawal rate was 5%.

HSWR50 consists of 50% stocks (S&P500 index) and 50% commercial paper. The withdrawal rate was 5%.

SwAT2 consists of stocks (S&P500) and TIPS at an interest rate of 2%. Allocations vary in accordance with Professor Robert Shiller’s P/E10. P/E10 has predictive power in the intermediate-term. It is the price (index level) of the S&P500 divided by the average of its most recent ten years of (trailing) earnings.

[Professor Shiller lists P/E10 and other S&P500 data at his web site.]
Professor Shiller's web site
Professor Shiller's data

Constraint A limits the allocations of both stocks and bonds to 25% to 75%. Benjamin Graham recommended such a constraint.

The stock allocation is 75% whenever P/E10 is less than 11. It is 40% whenever P/E10 is between 11 and 21. It is 25% whenever P/E10 is above 21.

The withdrawal rate was 6%.

SwOptT2 is similar to SwAT2, but without constraint A. It switches allocations in an optimal manner. The stock allocation is 100% whenever P/E10 is below 9. It is 50% whenever P/E10 is between 9 and 12. It is 30% whenever P/E10 is between 12 and 21. It is 20% whenever P/E10 is between 21 and 24. It is 0% whenever P/E10 is above 24.

The withdrawal rate was 6%.

HSWR80T2 consists of 80% stocks (S&P500 index) and 20% TIPS at a 2% interest rate. The withdrawal rate was 5%.

HSWR50T2 consists of 50% stocks (S&P500 index) and 50% TIPS at a 2% interest rate. The withdrawal rate was 5%.

I used my Deluxe Calculator version V1.1A08. It is a modified version of the Retire Early Safe Withdrawal Calculator, Version 1.61 dated November 7, 2002.

I started with initial balances of $100000. This makes it easy to convert to percentages. (Divide by 1000 and change $ to %).

All withdrawals are percentages of the initial balance in real dollars. That is, the amounts are adjusted to match inflation. I assigned higher withdrawal rates to portfolios SwAT2 and SwOptT2 (6% as opposed to 5%) because they perform better.

All balances are in real dollars. That is, after adjusting for inflation.

I set the expenses equal to 0.20% (of the portfolio’s current balance). I rebalanced annually. I used the CPI for inflation adjustments.

Tables

I have summarized my findings in four sets of tables. The first pair of tables examines 1921 to 1980. The second pair of tables (extended tables) examines 1871-1980.

Within each pair, one set of tables examines balances at years 5, 10, 11 and 12. The other set of tables examines the minimum balances within the first 5 years and within the first 10 years.

It is easy to convert balances to percentages of the initial balance. Divide by 1000 and change $ to %.

Portfolio Safety by Year
Extended Portfolio Safety by Year
Portfolio Safety by Minimum Balances
Extended Portfolio Safety by Minimum Balances

Major Insights

Sampling by year is more helpful than looking at the minimum balance. Neither is likely to tell a clear story at year 5. But both are likely to tell a very clear story by years 10, 11 and 12.

Almost always, if your portfolio has fallen to one-half of its value within the first ten years, it will fail. If it has recovered to 90% of its initial balance at years 10, 11 and 12 or grown larger, it is almost certain to succeed.

The lines between success and failure are defined adequately by years 10, 11 and 12. At least two-thirds of those portfolios that will succeed have balances above 90% of the initial balance (in terms of real dollars, after adjusting for inflation). Similarly, two-thirds of those portfolios that will fail have balances below 60% of the initial balance.

Balances above 60% and below 90% form an area of ambiguity. By year 12, almost all of the portfolios above 80% of the initial balance will survive.

The two portfolios with (allocation) switching behaved differently from the others. Survivors were usually easy to spot in years 10, 11 and 12, but failures were not. Many of the portfolios that eventually failed were still at 70%+ and 80%+ of the initial balance in years 10, 11 and 12. This behavior is stronger with the 1871-1980 data than with the 1921-1980 data.

This behavior is also apparent when looking at the minimum balances in the first ten years.

Summary

In the first 10-12 years and often sooner: more than two-thirds of the time, you will know if your portfolio is in danger.

In the first 10-12 years and often sooner: more than two-thirds of the time, you will know if your portfolio is safe.

There is a region of uncertainty. These are balances above 60% and below 90% of the starting balance.

Have fun.

John Walter Russell
July 17, 2005