Latching in a Gain

I used the Scenario Surfer to examine latching in a gain for the January 2009 stock market.

Conditions

I brought up the Scenario Surfer. I entered an initial balance of $100000. I withdrew $5000 (plus inflation) each year. I set the TIPS interest rate at 2%. I selected a P/E10=14 Bear Market.

I examined Year 15 balances.

I started with an initial stock allocation of 50%. I switched to a 100% stock allocation when P/E10 first fell below a threshold. I maintained this allocation through Year 15. That is, I latched onto the 100% stock allocation.

As an excursion, I used two thresholds. When P/E10 fell below the first threshold, I latched onto an 80% stock allocation. When P/E10 fell below the second threshold, I latched onto a 100% stock allocation.

Results

Allocate 50% stocks until P/E10 falls to 10. Then allocate 100% stocks.

Run 1. 56,651 [Year 9]
20% stocks: 52,174
50% stocks: 57,618
80% stocks: 58,687

Run 2. 48,219 [Year 1]
20% stocks: 46,386
50% stocks: 41,451
80% stocks: 31,022

Run 3. 110,302 [Year 1]
20% stocks: 53,794
50% stocks: 62,774
80% stocks: 67,908

Run 4. 64,651 [Year 5]
20% stocks: 51,787
50% stocks: 54,345
80% stocks: 48,645

Run 5. 96,404 [never]
20% stocks: 65,388
50% stocks: 96,404
80% stocks: 128,350

Latching provided a solid floor at Year 15.

P/E10 fell below 10 in 4 out of 5 runs. In the single instance when P/E10 stayed above 10, the Year 15 final balance was high enough to be satisfactory.

Allocate 50% stocks until P/E10 falls to 8. Then allocate 100% stocks.

Run 1. 116,847 [Year 3]
20% stocks: 56,423
50% stocks: 68,066
80% stocks: 73,856

Run 2. 76,820 [Year 7]
20% stocks: 51,701
50% stocks: 56,937
80% stocks: 58,374

Run 3. 54,422 [never]
20% stocks: 50,627
50% stocks: 54,422
80% stocks: 54,867

Run 4. 64,900 [never]
20% stocks: 54,828
50% stocks: 64,900
80% stocks: 70,996

Run 5. 76,802[never]
20% stocks: 58,451
50% stocks: 76,802
80% stocks: 93,537

Latching provided a spectacular success when it applied.

P/E10 fell below 8 in 2 out of 5 runs. The Year 15 balances were satisfactory in all instances.

Allocate 50% stocks until P/E10 falls to 6. Then allocate 100% stocks.

Run 1. 70,851 [Year 12]
20% stocks: 50,889
50% stocks: 54,304
80% stocks: 52,985

Run 2. 39,624 [never]
20% stocks: 44,482
50% stocks: 39,624
80% stocks: 32,838

Run 3. 88,341 [Year 13]
20% stocks: 60,039
50% stocks: 74,085
80% stocks: 78,859

Run 4. 68,026 [never]
20% stocks: 54,912
50% stocks: 68,026
80% stocks: 80,976

Run 5. 68,303 [never]
20% stocks: 58,659
50% stocks: 68,303
80% stocks: 62,270

Latching provided a good Year 15 balance when it occurred.

P/E10 fell below 6 in 2 out of 5 runs. The Year 15 balances were satisfactory in all but one instance.

Allocate 50% stocks until P/E10 falls to 10. Then allocate 80% stocks. If P/E10 falls below 8, allocate 100% stocks.

Run 1. 86,254 [Years 3 and 3]
20% stocks: 51,308
50% stocks: 51,924
80% stocks: 42,113

Run 2. 37,802 [Years 5 and 5]
20% stocks: 42,390
50% stocks: 33,561
80% stocks: 22,161

Run 3. 67,468 [never]
20% stocks: 54,618
50% stocks: 67,468
80% stocks: 80,640

Run 4. 96,475 [Years 4 and 6]
20% stocks: 62,964
50% stocks: 71,023
80% stocks: 71,674

Run 5. 78,249 [Years 9 and never]
20% stocks: 54,092
50% stocks: 65,609
80% stocks: 76,600

Latching provided good results at Year 15.

P/E10 fell below 10 in 4 out of 5 instances. P/E10 fell below 8 in 3 out of 5 runs. The Year 15 balances were satisfactory in all but one instance.

Conclusions

It is a good idea to latch to 100% stocks when P/E10 falls below 10 or 8. Waiting for P/E10 to drop to 6 may be too long. There was no clear cut advantage in using the two threshold excursion that I tried.

Remarks

We have a very difficult time spotting turning points when a market changes from a long lasting (secular) Bear Market to a long lasting (secular) Bull Market and vice versa. You can expect P/E10 to fall below 10. There is much more risk if you wait for P/E10 to fall below 8.

Have fun.

John Walter Russell
October 11, 2009