Learning the RIGHT Lessons

I continue to play with my Simplified Retirement Trainer A. Most recently, following my earlier Accumulation and the Retirement Trainer study, I have made a series of practice runs with Dollar Cost Averaging starting from a balance of $0. I have placed them into my Yahoo Briefcase. You can download Accumulation Summary A from my Retirement Trainers folder.

I did best on my first run and on my fifth. Glancing at the Year 30 balances doesn’t tell us the entire story. In fact, that is the wrong place to look for the most important lessons.

Initial Glimpse at the Data

Here are the Year 30 Balances. They provide us our first look. We can learn some early lessons even at this stage.

Annual investments: $5000 total, each year, starting from $0.

Year 30 Balances

Dollar Cost Averaging entirely into TIPS

In all cases: $213923

Dollar Cost Averaging into 100% Stocks

a1 $497218
a2 $796149
a3 $565313
a4 $470566
a5 $502360
a6 $736770
a7 $353582
a8 $389387

Dollar Cost Averaging with Variable Allocations

First try.

a1 $628085
a2 $916362
a3 $566726
a4 $489726
a5 $750677
a6 $480086
a7 $481236
a8 $443426

Second Try.

2a1 $554007
2a2 $797604
2a3 $601564
2a4 $492845
2a5 $678519
2a6 $379180
2a7 $436950
2a8 $432117

Third Try: Systematic with 21 and 14.

a1 $536461
a2 $837906
a3 $728859
a4 $491976
a5 $868711
a6 $213923
a7 $321790
a8 $460544

Fourth Try. 14 and 20 and 20%.

a1 $579908
a2 $793306
a3 $650031
a4 $506965
a5 $743496
a6 $388067
a7 $448642
a8 $431860

Fifth Try. 14 and 20 and load up on stocks early.

a1 $526090
a2 $797640
a3 $627657
a4 $489726
a5 $705783
a6 $488248
a7 $571636
a8 $421390

Initial Observations

Staying out of stocks entirely produced the worst outcome at Year 30.

Investing in stocks-alone produced two sub par conditions, with balances below $400000.

In terms of minimum balances, the first and the fifth try produced the best results. The second try showed that it was possible for me to lose ground.

In the third try, I tried to introduce a mechanical process. I used the 20% and 80% (inner) confidence limits in a Bear Market to define two P/E10 levels: 14 and 21. I intended to buy at the lower P/E10 level and sell at the higher, a form of latch-and-hold. The P/E10=14 level turned out to be a disaster. It kept me out of stocks entirely in run 3a6 (third try, run a6).

I tried to correct this on the fourth try by setting a 20% lower stock allocation goal. In addition, I changed the levels to P/E10=14+ (actually, 14.9) and 20. This helped, but it did not bring the run 4a6 (fourth try, run a6) balance above $400000. Changing from a numerical 20% goal to a less specific “load up on stocks early” instruction brought up all Year 30 balances above $400000.

In some ways, my first try was still the best. It did not come with clear instructions.

To put matters into context, run a6 is out of the ordinary. The secular Bear Market low always stays above historically typical levels. It never falls below P/E10=15.

Initial Conclusions

We should invest in stocks some of the time, but not necessarily all of the time.

We should pay attention to valuations.

We need to be careful to avoid rules that depend on these particular runs. Having an unusual run (a6) helps us keep our balance. It is not sufficient to acknowledge that we have a chance of getting blindsided. We need to be able to handle a special situation.

Year 10 and Year 20 Balances

Annual investments: $5000 total, each year, starting from $0.

Year 10 Balances

Dollar Cost Averaging entirely into TIPS

In all cases: $56467

Dollar Cost Averaging into 100% Stocks

a1 $80640
a2 $49754
a3 $38565
a4 $68810
a5 $35944
a6 $81950
a7 $65690
a8 $47310

Dollar Cost Averaging with Variable Allocations

First try.

a1 $91337
a2 $51947
a3 $52109
a4 $74595
a5 $50197
a6 $78285
a7 $72062
a8 $55675

Second Try.

2a1 $79082
2a2 $51947
2a3 $55996
2a4 $73810
2a5 $50751
2a6 $69882
2a7 $66284
2a8 $58579

Third Try: Systematic with 21 and 14.

a1 $56467
a2 $59589
a3 $61021
a4 $75659
a5 $56467
a6 $56467
a7 $56467
a8 $60640

Fourth Try. 14 and 20 and 20%.

a1 $70956
a2 $53904
a3 $55996
a4 $73810
a5 $49416
a6 $65698
a7 $63102
a8 $54735

Fifth Try. 14 and 20 and load up on stocks early.

a1 $86785
a2 $52675
a3 $46233
a4 $74595
a5 $43957
a6 $78555
a7 $69611
a8 $53319

Year 20 Balances

Dollar Cost Averaging entirely into TIPS

In all cases: $126663

Dollar Cost Averaging into 100% Stocks

a1 $151967
a2 $190451
a3 $118820
a4 $131344
a5 $352747
a6 $219802
a7 $192344
a8 $225353

Dollar Cost Averaging with Variable Allocations

First try.

a1 $202201
a2 $195227
a3 $139894
a4 $138286
a5 $400498
a6 $199781
a7 $248133
a8 $245830

Second Try.

2a1 $174810
2a2 $195227
2a3 $145463
2a4 $141882
2a5 $416090
2a6 $175778
2a7 $224140
2a8 $242932

Third Try: Systematic with 21 and 14.

a1 $168866
a2 $168866
a3 $154890
a4 $139594
a5 $448812
a6 $126663
a7 $210390
a8 $257325

Fourth Try. 14 and 20 and 20%.

a1 $184295
a2 $196808
a3 $145613
a4 $145202
a5 $415711
a6 $166849
a7 $225014
a8 $237151

Fifth Try. 14 and 20 and load up on stocks early.

a1 $164590
a2 $196233
a3 $130628
a4 $138286
a5 $371277
a6 $208979
a7 $286405
a8 $239830

Observations from Years 10 and 20

With TIPS-only, your balance at Year 10 would be $56467. Dollar cost averaging into an all-stock portfolio produced two balances out of eight that were below $40000. The balance for run a3 was $38565. For run a5, it was $35944.

This draws our attention to a huge problem. How do you stay with an approach in the face of a decade of losses?

Even if you make it through the first decade, you may have difficulty making it through the second. There are still two cases out of eight with disappointing performance (runs a3 and a4).

Looking carefully at the other conditions, when balances were low at Years 10 and 20, P/E10 levels were also low. Dividend yields would be more than twice as high as they are today. A retiree might be dissatisfied with his balance, but he would not be disappointed with his income.

The RIGHT Lessons

Here are the RIGHT lessons when dollar cost averaging over a long period of time:

1) You should invest in stocks at least part of the time.
2) You should NOT automatically invest into stocks ALL of the time.
3) You should seek to invest more into stocks early.
4) You should pay attention to valuations.

Worthy of special emphasis:

5) If you pay attention to valuations and if your balance has not grown as much as you would like, it will be because valuations are low, dividends are high and future prospects are outstanding.

Have fun.

John Walter Russell
September 22, 2006