Very Heavily Edited: Gradually Increasing Bond Allocations: Returns
The traditional advice to investors is to increase bond allocations as they age.
I have collected 10, 20 and 30-year real, annualized total returns.
Valuations
I use Professor Robert Shiller’s P/E10 as my measure of valuation.
Professor Shiller’s Web Site
Why P/E10?
Deluxe Calculator V1dot1A08P05
Deluxe Calculator V1dot1A08P05 is a modified version of the standard Deluxe Calculator V1.1A08.
All of the changes were made to the portion without rebalancing.
The algorithm subtracts increments from the stock total and adds them to the bond total.
The increment equals the initial BOND principal plus inflation divided by the length of the ladder. When the initial stock allocation is 50%, the initial bond allocation is 50%. With a 30-year ladder, the increment is 3.33% of the initial BOND balance (plus inflation). This works out to 1.67% of the initial balance of the overall portfolio. With a 60-year ladder, the increment is 1.67% of the initial BOND balance, which is 0.83% of the initial balance of the overall portfolio.
Data Collection
Real, Annualized Total Returns
I set the withdrawal rate equal to 0.00%.
I set the expense ratio to 0.00% of the initial balance. I used the CPI for inflation.
I set the calculator for NO rebalancing.
I used the S&P500 index for stocks. I used 2.00% I-Bonds for the component other than stocks.
Special Comments Regarding Data Collection
I have standardized on using I-Bonds with my TIPS Ladder Calculators.
Total return data that I took with TIPS did show differences when there was deflation. However, there were no differences in the maximum and minimum returns.
Real, Annualized Total Returns
I determined Calculated Return directly from the regression equation. The odds are (roughly) 50%-50% that the total return exceeds Calculated Return.
The odds are (roughly) 95% that the return will exceed lower confidence limit. The odds are (roughly) 95% that the return will be lower than the higher confidence limit.
At Year 10 Summary
Today’s Returns
Today’s earnings yield is 3.5%.
Lower Confidence Limit, Calculated Return, Higher Confidence Limit at year 10.
80% Stocks/30 year ladder: (4.5%) 1.11% 6.1%
80% Stocks/60 year ladder: (4.7%) 1.11% 6.1%
50% Stocks/30 year ladder: (1.5%) 1.49% 4.5%
50% Stocks/60 year ladder: (2.0%) 1.52% 4.9%
Year 2000 Returns
January 2000 P/E10 was 43.77.
Lower Confidence Limit, Calculated Return, Higher Confidence Limit at year 10.
80% Stocks/30 year ladder: (6.0%) (0.43%) 4.6%
80% Stocks/60 year ladder: (6.2%) (0.44%) 4.6%
50% Stocks/30 year ladder: (2.5%) 0.46% 3.5%
50% Stocks/60 year ladder: (3.0%) 0.47% 3.9%
At Year 20 Summary
Today’s Returns
Today’s earnings yield is 3.5%.
Lower Confidence Limit, Calculated Return, Higher Confidence Limit at year 20.
80% Stocks/30 year ladder: 0.0% 2.15% 6.0%
80% Stocks/60 year ladder: 0.0% 2.22% 6.0%
50% Stocks/30 year ladder: 0.3% 1.73% 4.1%
50% Stocks/60 year ladder: 0.6% 1.98% 4.5%
Year 2000 Returns
January 2000 P/E10 was 43.77.
Lower Confidence Limit, Calculated Return, Higher Confidence Limit at year 20.
80% Stocks/30 year ladder: (1.2%) 0.98% 4.8%
80% Stocks/60 year ladder: (1.1%) 1.06% 4.9%
50% Stocks/30 year ladder: (0.5%) 0.87% 3.3%
50% Stocks/60 year ladder: (0.3%) 1.11% 3.6%
At Year 30 Summary
Today’s Returns
Today’s earnings yield is 3.5%.
Lower Confidence Limit, Calculated Return, Higher Confidence Limit at year 30.
80% Stocks/30 year ladder: 2.8% 4.38% 6.4%
80% Stocks/60 year ladder: 2.6% 4.58% 6.6%
50% Stocks/30 year ladder: 1.7% 2.47% 4.0%
50% Stocks/60 year ladder: 2.3% 3.32% 4.8%
Year 2000 Returns
January 2000 P/E10 was 43.77.
Lower Confidence Limit, Calculated Return, Higher Confidence Limit at year 30.
80% Stocks/30 year ladder: 2.3% 3.86% 5.9%
80% Stocks/60 year ladder: 2.1% 4.09% 6.1%
50% Stocks/30 year ladder: 1.1% 1.89% 3.4%
50% Stocks/60 year ladder: 1.8% 2.84% 4.3%
Observations
At year 10:
The Calculated Returns slightly favor 50% Stocks at today’s valuations.
The Calculated Returns are almost identical at Year 2000 valuations.
The spread is much greater with 80% stocks than with 50% stocks.
At year 20:
The Calculated Returns are ambivalent as to the stock allocation.
The Calculated Returns slightly favor longer ladders.
The spread is much greater with 80% stocks than with 50% stocks.
At year 30:
The Calculated Returns favor an 80% initial stock allocation.
The Calculated Returns slightly favor longer ladders.
The spread is a little bit greater with 80% stocks than with 50% stocks.
Calculated Returns differ significantly at year 30. This is in contrast with shorter time intervals.
Have fun.
John Walter Russell
October 2, 2005