Edited TIPS Switching Survey Overview

I refer to any approach that changes allocations according to the level of P/E10 (or some other indicator) as switching. Switching is based on the old, commonsense notion that you should reduce your stock allocation when their prices are high and that you should increase your stock allocation when stock prices are low. Notice that we change allocations based on stock prices, not on the market's short-term outlook.

These are the optimized results for varying allocations for a portfolio consisting of stocks (as represented by the S&P500 index) and TIPS with a 2% (real) interest rate.

I used the TIPS version of a modified version of the Retire Early Safe Withdrawal Calculator, the JanSz-Chips Deluxe V2.0B TIPS. You can use any of my newer calculators if you wish to duplicate these results.

Optimization turned out to be much more difficult than I had anticipated and my progress was awkward. I am satisfied that I have come reasonably close to the true optimal values.

Conditions

All results are for retirement periods starting in 1921-1980. All portfolios consisted of stocks as represented by the S&P500 index (with all dividends reinvested) and 2% TIPS. Expenses were 0.20%. I re-balanced all portfolios annually at zero cost.

These Historical Surviving Withdrawal Rates are the highest withdrawal rates:

1) that would have produced a positive balance for an entire 30-year period,
2) but which would have had a negative or zero balance in at least one historical sequence (beginning in 1921-1980) when the withdrawal rate was increased by 0.1%.

Withdrawal rates are in terms of the portfolio’s initial balance. All withdrawal rates are in increments of 0.1%. Withdrawal amounts were adjusted to match inflation. The interest from TIPS also matched inflation and they decreased during times of deflation. TIPS were treated as trading vehicles without any capital gains or losses and there was never any adjustment back to par at maturity. Inflation was measured according to the Consumer Price Index for Urban workers (CPI-U).

P/E10 is the current (real) price of the S&P500 index divided by the average of the previous ten years of (real) earnings. This indicator of valuation (P/E10) was developed and is reported by Professor Shiller of Yale.

Visti Professor Shiller's web site for P/E10 and other S&P500 data.

Professor Shiller's web site

Summary

The best Historical Surviving Withdrawal Rate was 5.2% in all cases. It was never possible to reach 5.3% without several failures.

The simplest approach uses two thresholds and one adjustable stock allocation (for a total of three). The best choices are P/E10 thresholds of 11 and 24 and stock allocations of 100%-30%-0%, respectively.

When there is more than one, the most important thresholds are the lowest thresholds.

The best choice with three thresholds and two adjustable allocations (for a total of four) is to use P/E10 thresholds of 9-13-24 with stock allocations of 100%-50%-30%-0%, respectively. [Results with 100%-60%-30%-0% allocations and P/E10 thresholds of 9-13-24 are almost identical. Using P/E10 thresholds of 9-12-24 is another a good choice.]

The best choice with four thresholds and three adjustable stock allocations (for a total of five) are 9-12-21-24 or 9-13-21-24 (with no preference) with 100%-50%-30%-20%-0%, respectively. There is relatively little sensitivity to changing the lowest adjustable allocation or the lower middle P/E10 threshold.

Final Remarks

I am satisfied that the highest Historical Surviving Withdrawal Rate of 5.2% is a consistent ceiling using simple P/E10 thresholds. I am satisfied that the best reason for using additional thresholds and allocations is to reduce the sensitivity of results to minor differences from the optimal values. That is, I expect that the optimal values in the future will be similar to those extracted from historical data, but not identical. It is important to reduce the effects of errors that are caused by our dependence on historical data.

Have fun.

John Walter Russell