Delayed Purchase Withdrawals

Even though it failed to meet its goal, the approach in Almost 5% is a good example of the delayed purchase concept. It succeeded 9 out of 10 times. Fixed allocations of 20% and 50% stocks succeeded only 2 out of 10 times. A fixed allocation of 80% stocks succeeded 4 out of 10 times.

Close examination of Almost 5% data directs our attention to the waiting period as valuations return to normal. We must prepare for an extended period to assure safety.

Observations from Almost 5%

Almost 5% used a delayed purchase until P/E10=15.There were two instance in which it took 10 years for P/E10 to fall from 26 to 10. Both succeeded. There was one instance in which it took 12 years. It failed.

I used a 1% TIPS interest rate in Almost 5%. At Year 10 with 5% withdrawals (plus inflation), the balance would be down to 58% of the original balance (plus inflation). The drawdown at Year 12 proved to be too severe for a guaranteed recovery.

New Data

I looked at delayed purchases with thresholds of 12 (rounded) and 9 (rounded). I made three runs each on the Scenario Surfer.

With a threshold of 12, one out of three runs failed. In that instance, it took 14 years before P/E10 fell to 12 (rounded). With a threshold of 9, three out of three runs failed. It took a minimum of 15 years before P/E10 fell to 9 (rounded). Considering the 1% TIPS interest rate and the 5% (plus inflation) withdrawal rate, it is easy to understand the reason for failure. The remaining balance had fallen too low.

The Message

The message is loud and clear. With a delayed purchase concept, we must prepare for the worst case: failure to reach the threshold. We can do this by limiting early withdrawals, possibly to 4% (plus inflation). We can do this by easing into stocks (as with Valuation Informed Indexing).We need to be careful not to set the threshold too low.

The Scenario Surfer tells us what is likely based on two forms of mean reversion. Alternative approaches, based on historical observations, suggest a substantial reduction in P/E10 within a decade. Another alternative, the possibility of a recession, suggests and even earlier timeframe. Preparing for the worst case makes sense regardless.

Have fun.

John Walter Russell
February 21, 2008

Almost 5%