When Price Drops Occur (Retirement)

I varied allocations according to valuations in a retirement portfolio for 30 years. I determined when price drops occurred.

I found that varying allocations is vastly superior to maintaining fixed allocations (i.e., rebalancing). I found that it removes the sensitivity as to when price drops occur and how deep they are.

Scenario Surfer Runs

I invested entirely in stocks and 2% TIPS. I started with a $100000 balance. I selected P/E10=26 Bear Market. I withdrew $5000 (plus inflation) each year. Here are the Year 30 balances. I varied allocations in accordance with valuations as measured by P/E10. P/E10 values are in “Current Years” in the “Portfolio Allocation” box.

Run 1.
P/E10 below 20 in Year 2.
P/E10 below 15 in Year 5.
P/E10 below 10 in Year 14.
20% rebalanced: bankrupt in Year 27.
50% rebalanced: bankrupt in Year 28.
80% rebalanced: bankrupt in Year 24.
Valuation Informed Indexing: 204,913.

Run 2.
P/E10 below 20 in Year 6.
P/E10 below 15 in Year 6.
P/E10 below 10 in Year 22.
20% rebalanced: bankrupt in Year 26.
50% rebalanced: bankrupt in Year 25.
80% rebalanced: bankrupt in Year 24.
Valuation Informed Indexing: 38,859.

Run 3.
P/E10 below 20 in Year 7.
P/E10 below 15 in Year 10.
P/E10 below 10 in Year 25.
20% rebalanced: bankrupt in Year 30.
50% rebalanced: 43,139.
80% rebalanced: 92,575.
Valuation Informed Indexing: 108,238.

Run 4.
P/E10 below 20 in Year 2.
P/E10 below 15 in Year 3.
P/E10 below 10 never.
20% rebalanced: bankrupt in Year 29.
50% rebalanced: 10,641.
80% rebalanced: 17,043.
Valuation Informed Indexing: 72,854.

Run 5.
P/E10 below 20 in Year 6.
P/E10 below 15 in Year 14.
P/E10 below 10 in Year 24.
20% rebalanced: bankrupt in Year 28.
50% rebalanced: 4,647.
80% rebalanced: 10,848.
Valuation Informed Indexing: 116,745.

Run 6.
P/E10 below 20 in Year 12.
P/E10 below 15 in Year 12.
P/E10 below 10 never.
20% rebalanced: bankrupt in Year 29.
50% rebalanced: 30,935.
80% rebalanced: 78,249.
Valuation Informed Indexing: 77,466.

Run 7.
P/E10 below 20 in Year 8.
P/E10 below 15 in Year 13.
P/E10 below 10 never.
20% rebalanced: bankrupt in Year 27.
50% rebalanced: bankrupt in Year 28.
80% rebalanced: bankrupt in Year 30.
Valuation Informed Indexing: 18,732.

Run 8.
P/E10 below 20 in Year 4.
P/E10 below 15 in Year 5.
P/E10 below 10 in Year 6.
20% rebalanced: bankrupt in Year 26.
50% rebalanced: bankrupt in Year 23.
80% rebalanced: bankrupt in Year 18.
Valuation Informed Indexing: 25,216.

Run 9.
P/E10 below 20 in Year 10.
P/E10 below 15 in Year 11.
P/E10 below 10 never.
20% rebalanced: bankrupt in Year 30.
50% rebalanced: 47,717.
80% rebalanced: 100,948.
Valuation Informed Indexing: 125,385.

Run 10.
P/E10 below 20 in Year 9.
P/E10 below 15 in Year 10.
P/E10 below 10 in Year 28.
20% rebalanced: 1,557.
50% rebalanced: 38,004.
80% rebalanced: 54,780.
Valuation Informed Indexing: 55,451.

Data Summary

Here are the balances ordered in terms of when P/E10 first falls below 20:

P/E10 below 20 in Year 2: balances 204,913, 72,854.
P/E10 below 20 in Year 4: balance 25,216.
P/E10 below 20 in Year 6: balances 38,859, 116,745.
P/E10 below 20 in Year 7: balance 108,238.
P/E10 below 20 in Year 8: balance 18,732.
P/E10 below 20 in Year 9: balance 55,451.
P/E10 below 20 in Year 10: balance 125,385.
P/E10 below 20 in Year 12: balance 77,466.

Here are the balances ordered in terms of when P/E10 first falls below 15:

P/E10 below 15 in Year 3: balance 72,854.
P/E10 below 15 in Year 5: balances 204,913, 25,216.
P/E10 below 15 in Year 6: balance 38,859.
P/E10 below 15 in Year 10: balances 108,238, 55,451.
P/E10 below 15 in Year 11: balance 125,385.
P/E10 below 15 in Year 12: balance 77,466.
P/E10 below 15 in Year 13: balance 18,732.
P/E10 below 15 in Year 14: balance 116,745.

Here are the balances ordered in terms of when P/E10 first falls below 10:

P/E10 below 10 in Year 6: balance 25,216.
P/E10 below 10 in Year 14: balance 204,913.
P/E10 below 10 in Year 22: balance 38,859.
P/E10 below 10 in Year 24: balance 116,745.
P/E10 below 10 in Year 25: balance 108,238.
P/E10 below 10 in Year 28: balance 55,451.
P/E10 below 10 never: balances 72,854, 77,466, 18,732, 125,385.

Here are the P/E10 thresholds versus the ordered Year 30 balances:
204,913 and years 2, 5 and 14.
125,385 and years 10, 11 and never.
116,745 and years 6, 14 and 24.
108,238 and years 7, 10 and 25.
77,466 and years 12, 12 and never.
72,854 and years 2, 3 and never.
55,451 and years 9, 10 and 28.
38,859 and years 6, 6 and 22.
25,216 and years 4, 5 and 6.
18,732 and years 8, 13 and never.

Data Analysis

Varying allocations produced the largest final balance in 9 out of 10 instances. Using fixed allocations often led to bankruptcy.

I found no obvious relationship between the final balance and when a price drop occurred. Nor did I find any obvious relationship between the final balance and how deep the price drop was.

Conclusions

Varying allocations according to valuations (Valuation Informed Indexing) removes the sensitivity as to when a price drop occurs and how deep the price drop is.

Varying allocations according to valuations (Valuation Informed Indexing) is vastly superior to using fixed allocations.

Have fun.

John Walter Russell
May 20, 2008