A Story for Accumulators
I collected two sets of data on the Scenario Surfer. They tell a story. Listen closely.
The Data
I dollar cost averaged for 10 years. I started with $1000 and added $1000 each year thereafter. I invested entirely in stocks when P/E10 fell below 20 and entirely in 2% (real interest) TIPS when P/E10 rose above 20.
[Explanatory note: when P/E10=20, the odds of a loss ten years into the future is around 20%. The upside potential has a 20% chance of exceeding 6% (plus inflation).]
I looked at a P/E10=26 Bear Market and a P/E10=8 Normal Market. I took 5 runs at each condition.
Balances are at Year 10. I include fixed stock-TIPS allocations for purposes of comparison.
P/E10=26 Bear Market
Run: 1 Varying allocations: 13407 20% stocks: 12646 50% stocks: 12774 80% stocks: 12615
Run: 2 Varying allocations: 15312 20% stocks: 12512 50% stocks: 12592 80% stocks: 12563
Run: 3 Varying allocations: 13731 20% stocks: 12380 50% stocks: 12298 80% stocks: 12129
Run: 4 Varying allocations: 15131 20% stocks: 12289 50% stocks: 11737 80% stocks: 10741
Run: 5 Varying allocations: 6022 20% stocks: 10992 50% stocks: 8931 80% stocks: 6925
*Run: 5 Year 9 Varying allocations: 11146 20% stocks: 11011 50% stocks: 10784 80% stocks: 10529
P/E10=8 Normal Market
Run: 1 Varying allocations: 21433 20% stocks: 13833 50% stocks: 16341 80% stocks: 19259
Run: 2 Varying allocations: 21906 20% stocks: 13958 50% stocks: 16606 80% stocks: 19643
Run: 3 Varying allocations: 20834 20% stocks: 13768 50% stocks: 16111 80% stocks: 18809
Run: 4 Varying allocations: 25400 20% stocks: 14473 50% stocks: 18066 80% stocks: 22252
Run: 5 Varying allocations: 29646 20% stocks: 14841 50% stocks: 19358 80% stocks: 25063
Observations
It was looking as if varying stock allocations was always the best way to go until run 5 of the P/E10=26 Bear Market. A horrible price drop in Year 10 wiped out a substantial amount of money. There really is such a thing as risk.
In the P/E10=8 Normal Market, my plans to vary allocations ended up with my being 100% in stocks at all times. This was always the best decision. Valuations were so favorable that the right decision was always 100% stocks.
Rule of Thumb
The rule of thumb is that you should think about preserving capital when you have capital to preserve. There is a bitter contrast between Years 9 and 10 of Run 5 in the P/E10=26 Bear Market.
The downside risk showed up at the least opportune time. This is why it pays to vary allocations in accordance with valuations. This is why you should vary allocations in accordance with valuations as soon as you have a big enough nest egg to protect. Downside risk is real. Losses are real.
Have fun.
John Walter Russell October 19, 2007
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