Playing with the Toy

I simulated three “what-if” scenarios on my Bull Bear Retirement Trainer B. It is my new toy.

I started with today’s valuations, P/E10=27.3 and today’s TIPS interest rate of 2.2%. I specified that we are in a secular Bear Market. I sought to maintain a 5% withdrawal rate.

Conditions

I brought up Super Variable Terminal Value Rate SVTVR Calculator L. I set the Year 30 balance to zero.

With Switching Algorithm A, the Safe Withdrawal Rate was 4.20%. The Reasonably Safe rate was 4.55%. The Likely Success rate was 4.90%.

[More precisely, withdrawal rates less than or equal to 4.20% are safe. Withdrawal rates between 4.20% and 4.55% are reasonably safe. Withdrawal rates between 4.55% and 4.90% are likely to be successful. At 4.90%, the chances are about 50%-50% of having a positive balance in Year 30.]

Switching Algorithm A varies stock allocations with the current year’s P/E10. It constrains stock allocations between 20% and 80%.

With Switching Algorithm B, the Safe Withdrawal Rate was 4.35%. The Reasonably Safe rate was 4.77%. The Likely Success rate was 5.18%.

Switching Algorithm B varies stock allocations according to the current year’s P/E10. It allows the stock allocation to vary between 0% and 100%.

With a fixed 50% stock allocation (rebalanced annually), the Safe Withdrawal Rate was 3.64%. The Reasonably Safe rate was 4.03%. The Likely Success rate was 4.43%.

With a fixed 80% stock allocation (rebalanced annually), the Safe Withdrawal Rate was 2.97%. The Reasonably Safe rate was 3.59%. The Likely Success rate was 4.21%.

The Almost Certain Failure rates for Switching A, Switching B, fixed 50% stocks and fixed 80% stocks were 6.01%, 6.18%, 5.62% and 5.99%, respectively.

Clearly, the odds were against me. The best switching algorithms set the Likely Success rates at 4.90% and 5.18% (i.e., Switching A and Switching B, respectively, 50%-50% odds of having a positive balance in Year 30).

Run 1

I started with $1000000. I put it all into TIPS. I withdrew $50000 each year for five years (through the end of Year 4). P/E10 peaked at 29.2 at the beginning of Year 2.

I continued to withdraw $50000 each year.

I missed out when P/E10 jumped to 31.4 in Year 5. It fell back to 23.6 in Year 5. P/E10 fell to 20.7 at the beginning of Year 7.

My balance at the beginning of Year 7 was $782352. I “withdrew” a negative $100000 from stocks. That is, I deposited $100000 into stocks and withdrew $150000 from TIPS.

Stocks tumbled. P/E10 fell to 13.3 at the beginning of Year 8. My starting balance was $714834. I “withdrew” a negative $200000 from stocks. That is, I deposited $200000 into stocks and withdrew $250000 from TIPS. P/E10 held at 13.4 at the beginning of Year 9. My starting balance for Year 9 was $694117.

I continued to withdraw $50000 each year. But now, I started to withdraw $20000 from stocks (and $30000 from TIPS).

P/E10 fell to 10.1 at the beginning of Year 10. My starting balance was $600050. I “withdrew” a negative $100000 from stocks. That is, I deposited $100000 into stocks and withdrew $150000 from TIPS. My stock balance was $316819. My TIPS balance was $233231.

P/E10 rose to 10.6 in Year 11. My initial balance was $594782. This time, I increased my stock withdrawals to $30000 (and $20000 from TIPS). I continued doing so until the beginning of Year 24.

At the beginning of Year 24, I had a balance of $12244 in my TIPS account. Stocks had done well. My stock balance was $226160.

I decided against adding to my TIPS account. P/E10 was only 11.3. I increased my stock withdrawal to $50000. I left the TIPS account alone.

At the beginning of Year 26, my balance was $127611. P/E10 was 8.9.

I reduced my withdrawal amount to $40000. I withdrew $26930 from stocks and $12789 from TIPS, which depleted my TIPS account. After that, I withdrew $40000 from stocks.

At the beginning of Year 29, my account balance was $13313.

I was able to withdraw $50000 for 26 years. [Remember that the first Year is “0”.] I withdrew $40000 for 3 more years. I did not make it all the way to Year 30. I was only able to withdraw $13313 in Year 30.

Run 2

Once again, I started with $1000000. Once again, I put it all into TIPS. Once again, I withdrew $50000 each year.

P/E10 peaked at 31.4 at the beginning of Year 5. At Year 7, P/E10 began at 20.7. My balance was $782352. I withdrew” a negative $100000 from stocks.

P/E10 fell abruptly to 13.3 at the beginning of Year 8. My balance was $714834. I “withdrew” a negative $200000.

Once again, I withdrew $0 from stocks and $50000 from TIPS, gradually allowing my TIPS balance to fall.

At the beginning of Year 17, P/E10 was 10.4. My balance was $422222. My TIPS balance was $39426.

I kept my total withdrawals at $50000, but I withdrew $150000 from stocks, which added $100000 to my TIPS account.

At the beginning of Year 18, P/E10 was 11.3. My balance was $410293. I proceeded to withdraw $0 from stocks and $50000 from TIPS as I had done before.

At Year 20, P/E10 started at 11.2. My balance was $350257. I withdrew $150000 from stocks, which added $100000 to my TIPS balance.

Once more, I withdrew $0 from stocks and $50000 from TIPS, gradually allowing my TIPS balance to fall.

At Year 24, P/E10 started at 11.3. My balance was $204856. I withdrew $2988 from TIPS and $46946 from stocks. This depleted my TIPS account.

This time, I reduced my withdrawals to $40000 in Year 25. My account balance started at $157913. P/E10 started at 10.8.

This time, my balance was $24617 at the beginning of Year 28.

I was able to withdraw $50000 for 25 years. I was able to withdraw $40000 for 3 more years. I was only able to withdraw $24617 in the following year. I was bankrupt in Year 30.

Run 3

Gradually, I was getting the message. The power of my personality would not guarantee success when I withdrew $50000 from the start. This time, I cut back to $45000, which is in the Reasonably Safe region with Switching A and Switching B, but in the Likely Failure region with 50% and 80% fixed stock allocations.

This time I stayed with $0 in stocks until Year 7, when P/E10 started at 14.4. It had peaked at 30.5 at the beginning of Year 5. It had fallen to 19.6 at the beginning of Year 6.

At the beginning of Year 7, my balance was $820571. I transferred $200000 into stocks by “withdrawing” a negative $200000.

I continued withdrawing $45000 total. I went back to withdrawing $0 from stocks and $45000 from TIPS.

At the beginning of Year 12, P/E10 fell to 8.8. The initial balance was $621710. I “withdrew” another negative $200000 from stocks. I took $245000 from TIPS to finance the $45000 withdrawal plus $200000 for stocks.

I went back to withdrawing $0 from stocks and $45000 from TIPS.

At the beginning of Year 16, P/E10 was 15.3. My account balance had grown to $917594.

I withdrew $445000 from stocks. This covered the $45000 withdrawal and it replenished my TIPS account by $400000.

At the beginning of Year 17, P/E10 was 14.9. My account balance was $899272. I had $404241 in stocks and $495031 in TIPS.

I started withdrawing $20000 from stocks each year. I continued to withdraw $45000 total. The remaining $25000 came from TIPS.

At the beginning of Year 22, P/E10 was 9.3. My account balance was $679819, with $261381 in stocks.

I “withdrew” a negative $200000 from stocks. My total withdrawal amount was $45000.

I went back to withdrawing $0 each year from stocks and $45000 from TIPS.

At the beginning of Year 27, P/E10 was 12.3. My account balance was $853000. My TIPS balance was only $3253.

I withdrew $445000 from stocks, adding $400000 to TIPS and covering the standard $45000 withdrawal amount.

I went back to withdrawing $0 from stocks and $45000 from TIPS.

At the beginning of Year 30, P/E10 was 12.6. I had a balance of $841922.

Assessment

At the end of run 3, I brought Super SVTVR Calculator L back up. I specified an 80% Terminal Value Percentage.

With Switching A, the Likely Failure rate was 4.17%. The Almost Certain Failure rate was 4.64%.

With Switching B, the Likely Failure rate was exactly 4.50%.

With a fixed 50% stock allocation, the Almost Certain Failure rate was 4.12%.

With a fixed 80% stock allocation, the Likely Success rate was 4.21%. The Likely Failure rate was 5.10%. The Almost Certain Failure rate was 5.99%.

What made the difference was a single spectacular year, with a 50% gain in stocks, about one-half way through the total period. My stock allocation had grown to more than 80%. I locked in the gain a year later, when I transferred about half of my holdings into TIPS.

A Retirement Planning Insight

Bringing Super SVTVR Calculator L back up, I looked at the TIPS-only 30-Year Safe Withdrawal Rate. Guess what? It was 4.59%.

I ended up doing very well with a 4.5% withdrawal rate. I could have made it to Year 30 without owning any stocks at all. I did better when I added stocks at favorable valuations. I could have done much worse with a fixed allocation of stocks. The odds of having a positive balance at Year 30 are less than 50%-50% if with a fixed stock allocation at today’s valuations.

A TIPS-only baseline is a great starting point in the early years of a long lasting (secular) bear market.

Have fun.

John Walter Russell
September 1, 2006