What If There Is A Bubble?

Our TIPS/Dividends strategy looks great, starting today. But what if you had selected a dividend-based strategy back in 1995, before the bubble? You might have had to be out of the market for 20 years.

The answer: You would have done exceedingly well. Around 1995, you could have bought TIPS with a 4% (real) interest rate.

What about today? With today’s interest rates? What will happen if you have to wait 20 years before buying stocks?

The answer: You will be sitting pretty.

New Calculations

Once again, you can find the details in the articles about Dividend-Based Design Outline and Equations for Design.

Dividend-Based Design Outline
Equations for Design

Today’s TIPS yield more than 2% (real) to maturity. If you set up a TIPS ladder at a 2% (real) interest rate AND if you withdraw 4.0% of your initial balance (plus inflation) for 20 years, you end up with 51.4% of your initial balance (plus inflation).

[Here are the intermediate calculations. The 20-year TIPS equivalent safe withdrawal rate TESWR is 6.116%. The withdrawal rate is 4.0%. The TIPS interest rate is 2.0%. The remaining fraction equals [(6.116-4.0)/(6.116-2.0)] = 0.514.]

Assuming symmetry about the year 2000, P/E10 in January 2015 will be very close to what it was in January 1985. P/E10 was 9.997.

If an investor had started out in 1995 with 2.0% TIPS, he would still be able to look forward to P/E10 = 10 by year 20. If he had limited his withdrawal rate to 4.0% (plus inflation) during those 20 years, he would still have 51.4% of his principal left. With this, he would be able to buy high dividend stocks from high quality companies at yields of 6.9% to 10.4%. This translates to an income stream of 51.4% times 6.9% to 10.4% (plus inflation) that lasts far into the indefinite future.

This is a final income stream of 3.55% to 5.35% of the original balance (plus inflation). The most likely outcome is an income stream that starts at 4.0% (plus inflation) that jumps to 4.45% of the original balance (plus inflation) in year 20.

Summary

If a retiree starts out entirely in TIPS at today’s 2%+ interest rates and withdraws 4.0% of his original balance (plus inflation) for 20 years before he finds suitable high dividend stocks, he will still end up with a continual, long-lasting income stream greater than 3.55% of his original balance (plus inflation). Most likely, his income will increase to 4.45% of his original balance (plus inflation). His income stream could be as high as 5.35% of his original balance (plus inflation).

What if there is a bubble? You will be sitting pretty.

Traditional approaches don’t come close to matching this.

Have fun.

John Walter Russell
April 12, 2006