May 2006 Highlights
Our Roots
1. Our roots date back to May 13, 2002, when Rob Bennett asked a simple question. It was not allowed to be answered.
Our Roots
Restoring 4.0%
2. Back on May 13, 2002, it was generally accepted that the 30-Year Safe Withdrawal Rate with a fixed allocation of stocks and commercial paper was 4.0% of the initial balance (plus inflation). Later, it was clear from our research that it was not safe.
3. We had restored the 4.0% rate by May 2005. Instead of using stocks and commercial paper, we could use TIPS or ibonds. Even at a 1.0% interest rate, TIPS or ibonds can support a withdrawal rate of 3.87% (plus inflation) for 30 years. This increases to 3.99% (plus inflation) if the interest rate is 1.2%.
4. We had found that shifting allocations between TIPS and stocks could raise the 30-Year Safe Withdrawal Rate, possibly above 4.0%. This year, we showed that an optimized portfolio using 1.2% TIPS could deliver safety at today’s valuations (P/E10 = 27.5), while retaining the upward potential of stocks. It would have a 50%-50% chance of allowing withdrawals of 4.78% for 30 years. With 2% TIPS, the 30-Year Safe Withdrawal Rate is 4.29%. The odds are 50%-50% at 5.09%.
5. A similar portfolio, designed to tolerate human factors and estimation errors, has a 4.13% 30-Year Safe Withdrawal Rate at today’s valuations. The odds are 50%-50% at 4.48%.
Lifting the Bar
6. We extended our research to include intermediate-term timing. By waiting for favorable valuations, our prospects rise dramatically.
7. For planning purposes, you need to have $477K to $572K (plus inflation) ten years from now. This will produce an income stream of $40K (plus inflation) annually that lasts at least 30 years. These numbers assume that P/E10 falls to 8.7, which is likely.
8. Alternatively, it only takes $95K to $158K more if P/E10 drops only as far as 10 or 12 instead of 8.7. We do not need anything close to $1.0 million (plus inflation).
9. There are all sorts of opportunities using these numbers. Depending upon your circumstances, you might be able to cut back to part time work (i.e., semi-retire) right away. Or you might be able to retire in style in five or six years if you have $700K or $800K. You don’t need $1.0 million.
Lifting the Bar Even Higher
10. Combining intermediate-term timing and a dividend strategy raises today’s Safe Withdrawal Rate to 4.8% (plus inflation) using very conservative assumptions. No longer is there a limit on the timeframe. Such a portfolio provides an income stream that lasts indefinitely. Better yet, your income grows faster than inflation.
11. Under what I consider to be more accurate assumptions, today’s Safe Withdrawal Rate rises to 5.4% (plus inflation).
12. Intermediate-term timing has a theoretical failure mechanism: you have to wait for favorable valuations. Theoretically, you may never have an opportunity to buy stocks. My analysis shows that you would still be better off waiting for twenty years, if necessary. However, for those who are really concerned about this issue, I suggest starting with 100% TIPS at a withdrawal rate of 4.0% (plus inflation). Assuming that stocks never become attractive, your income stream would still last 35 years.
Simple Calculators
13. I have built a variety of easy to use spreadsheet calculators. They convert my equations into something more convenient.
14. You enter today’s value of P/E10, possibly to find the most likely range of stock returns over the next few decades. The calculator converts P/E10 into the equivalent S&P500 level to make things easier.
15. Similarly, you can enter today’s P/E10 and a TIPS interest rate to calculate a variety of withdrawal rates, ranging from Safe to Almost Certain Failure.
16. Even better, you have a choice of final balances. You may choose to calculate the standard 30-Year Safe Withdrawal Rates, which have a final balance of zero. You may choose to calculate 30-Year Constant Terminal Value Rates, which require that the balance at year 30 equals the initial balance (plus inflation). You may choose to look at 30-Year Half Constant Terminal Value Rates, which ends up with one-half of the initial balance (plus inflation) at year 30.
Letters to the Editor
17. I have initiated a variety of Current Research efforts. I have looked into Rob Bennett’s Valuation-Informed Indexing, which I call Lucky 7, based on the Roman numeral VII. But the most satisfying area of this site is the Letters to the Editor.
18. The Letters to the Editor cover a wide variety of topics. I make an extra effort to provide accurate, helpful replies.
Have fun.
John Walter Russell May 16, 2006
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