Letters to the Editor

Started May 1, 2006.

Updated August 9, 2006.

New Search Feature

I have added a new search feature at the bottom of this page. It includes an index and a site map.

To build a retirement portfolio

I received this letter from Subhankar (Bandy).

I came across your site just by an accident. I am very excited about this site. It is full of information. I was browsing the site [and] it appears to me [that] it is dedicated to a strategy of preserving your money after retirement. But my question is: “Do you have any advice regarding asset allocation during the wealth building stage?”

Thank you.

HERE IS MY RESPONSE

Yes, I do.

I have selected a few articles. I hope that you will be pleased.

Dollar cost averaging is good. But what about today’s stock market? My answer: preserve capital.

Dollar Cost Averaging Today: Edited

Here is an overview for the wealth building (accumulation) stage.

Accumulation Stage: Edited

This is a key finding.

POST D. Switching during Accumulation

We already have two important findings related to switching stock allocations during the accumulation stage. First, dollar cost averaging into a 100% stock portfolio is always best when the time frame is long. Second, switching allocations between stocks and TIPS at a 2% interest rate makes sense when you have already accumulated a large amount of money.

The following is critically important for those within 5 or 10 years of retirement. NOTE: I refer to the years immediately before retirement as the transition stage. The transition is between building wealth and receiving income.

POST E. Numbers for Transition Planning

Preserving capital becomes more and more important as one approaches retirement.
..
When valuations are very high, as they are today, stocks have a substantial downside risk. Their most likely returns are about the same as having a 100% TIPS portfolio.
..
Looking at the charts, the critical threshold seems to be an earnings yield just above 6%, which corresponds to a maximum P/E10 = 16 or 17. The median or typical historical value of P/E10 has been around 14.

Translating this into plain language: you should pay attention to preserving capital as you approach retirement unless stocks are cheap. They are not cheap. They are expensive.

Don’t be discouraged because of the earlier articles. I never stop by reporting bad news. Looking forward, there is a tremendous upside.

I Don’t Want to Wait
I Don't Want to Wait, But..

Here is a short article that you might find interesting.

An Illusion of Numbers

Calculators

Mike sent me this note.

Thanks for the new calculators, John.

IN RESPONSE:

I have decided to add even more calculators. My first is CTVR Calculator A.

Constant Terminal Value Rates (CTVR) are withdrawal rates that leave the balance at the end of a period identical to the initial balance plus inflation.

CTVR Calculator A is almost identical to Calculator H. It calculates 30-Year Constant Terminal Value Rates instead of rates that end with a zero balance.

Constant Terminal Value Rates are useful for young retirees. This Constant Terminal Value Rate Calculator is especially helpful when making comparisons with dividend strategies. Just understand that dividend amounts almost always grow substantially ahead of inflation over a 30 year period.

You can download it from my Yahoo Briefcase. It is CTVR Calc A in the Big Project folder.

Current Research H
Yahoo Briefcase

I have just added HCTVR Calculator A. It calculates 30-Year Half Constant Terminal Value Rates. Half Constant Terminal Value Rates (HCTVR) leave a final balance of one-half of the initial balance (plus inflation).

For young retirees, this defines an intermediate level of risk. It is not as restrictive as a Safe Withdrawal Rate. They can relax their safety demands at the Constant Terminal Value Rate, while maintaining a high level of safety at the Half Constant Terminal Value Rate.

Half Constant Terminal Value Rates also make sense for older retirees who have a chance of living beyond the 30-year planning period. At the Half Constant Terminal Value Rate, long life remains a blessing even if their retirement portfolio disappoints.

Making Comparisons Generates Insights:

"Why People Ignore Valuations" is a fantastic article.

I received this letter from Rob Bennett.

There's great power in the calculators you are developing because they permit comparisons of different investment scenarios. It is by making meaningful comparisons that the most powerful insights are developed.

You are pointing to an important truth in this article, in my view. TIPS were not available at earlier times. So comparisons to TIPS were not possible. When TIPS became available, the nature of the asset allocation game changed. Most investment analysts have not caught on to the significance of this change.

And valuation levels for stocks always need to be taken into consideration. Many of the tools that conventional analysts use are tools that were developed at times when stocks were at lower valuation levels. Those tools provide "highly misleading" (Bernstein's phrase) results when valuation levels change. Valuations should always be taken into consideration, in my view. But it becomes imperative to take valuations into account when valuations reach the levels they are at today.

HERE IS MY RESPONSE.

Rob Bennett deserves the credit for inspiring the current series of calculators. He recognized the need for people to be able to calculate Long-Term Stock Returns. He has encouraged the development of all of my simple spreadsheet calculators.

I appreciate Mike’s encouragement as well. Mike’s presence has always been a blessing.

Data reduction has always been a big part of any analysis. It always helps to summarize data in a meaningful, easy-to-understand manner.

I never would have thought of Why People Ignore Valuations if it weren’t for the new calculators. I was checking out my Variable Terminal Rate Calculators when the main finding jumped out at me. I kept getting the same high stock allocation for conditions that applied in the past, but not today.

Forsey-Sortino Method

I received this letter from Matthew.

Good Morning,

I've been researching the Forsey-Sortino method and would like to be able to calculate these on my own.

I see you have calculations and raw data on your Yahoo briefcase.

Is the Forsey-Sortino model on there as well?

Thanks!

HERE IS MY RESPONSE.

Unfortunately, no. The model comes with the purchase of the book, Managing Downside Risk in Financial Markets by Frank Sortino and Stephen Satchell. I bought my copy through Amazon. The publisher is Elsevier Butterworth-Heinemann with offices in Oxford, UK and Burlington, MA, USA. ISBN 0 7506 4863 5.

Clarification

What does “3% + inflation” mean?

I received this letter from David.

Sorry to be dense upon new arrival to your wonderful site, but this editor has to ask:

“Our TIPS-only baseline portfolio is powerful enough for you to withdraw 3.0% (plus inflation) of your initial balance for 45 to 50 years and it is truly safe.”

What does “3% + inflation” mean? That you can withdraw, from an all-TIPS portfolio, 5%-6% (3 + inflation) every year for a half-century without fear?

HERE IS MY RESPONSE

No. But don’t feel bad. I have made the same mistake.

The first withdrawal is 3% of the original balance. If there is a single year’s worth of 3% inflation, the withdrawal amount is multiplied by 1.03. After a single year of inflation, the withdrawal amount increases to 3.09% of the original balance.

Each year’s inflation adjustment multiplies the previous withdrawal amount by (1+the latest inflation rate). One way to keep up with this is to refer to the relevant inflation index, in this case the CPI. The index records the cumulative effect. Multiply the original withdrawal amount by the latest CPI value and divide the product by the CPI value when you made the original purchase.

There is a simpler, better way if you purchase TIPS. Take the ratio of the withdrawal percentage (in this case, 3%) to the coupon rate, in the example around 2%. Whenever you receive a coupon payment, multiply it by this ratio. This is the total amount to withdraw. (This requires that you drawdown some of your principal. If you have a TIPS ladder in place, you take this from TIPS that are maturing in the current year. Otherwise, there can be a capital gain or loss.) The Government already calculates the inflation adjustment when it sends you its coupon payment. In this case, withdraw 1.5 times (which is 3%/2% times) the coupon amount.

[If you could be assured of a 2% interest rate from TIPS for an entire 50 years, you would be able to withdraw 3.18% of your original balance (plus inflation). Today’s TIPS rate is close to 2.5%.]

So what happens to that other 3%? Why can’t we just add the coupon percentage and the inflation rate?

You will get the inflation adjustment (the 3%), but not until the TIPS mature. If the first year’s inflation rate is 3%, the Government increases the principal amount of a $1000 TIPS to $1030. In the meantime, the Government sends you the coupon rate times the new principal amount.

Earlier Letters to the Editor

Dave asked about 4% and hot selling books... Evelyn asked about TIPS. Dan noticed: TIPS yields moving higher. Mascha asked: Are you the psychic? Jeff was misinformed about Rob Bennett (Hocus).
March 22, 2006 Letters to the Editor

Mike asked about High Dividends: Half DVY, Half RWR. Don asked: Do visual aids or other simple tools exist? From Bud: Very cool stuff here followed by remarks about Exponential Weighting.
February 20, 2006 Letters to the Editor

Retirement Planning Tools Offer Dangerous Advice
February 14, 2006 Letters to the Editor

More Comments: This Time Inspired by "Dollar-Cost Averaging Today" and Comments Inspired by "Year 10 Choices."
February 5, 2006 Letters to the Editor

Comments Inspired by Reading "The Story Behind the Numbers" by Rob Bennett. My response, including Risky Alternatives, Dollar Cost Averaging Today and DCA Today: The Point of Frustration.
January 29, 2006 Letters to the Editor

Unclemick about the Dow Jones Utilities. BillW (with Thanks!) about getting started. Rob Bennett about Dividend Theory versus Dividend Reality. This led to a breakthrough.
January 11, 2006 Letters to the Editor

2005 Letters to the Editor
2005 Letters to the Editor