Simple VII Sensitivity Study

Valuation Informed Indexing offers a tremendous advantage over buy and hold. Here is a sensitivity study. It shows what happens to a simple variant. This time, I used a Bear Market exit point of P/E10=15 instead of 10.

The Calculator

I built a calculator to test the advantage of staying out of stocks whenever P/E10=20 and above. I kept the investor out of stocks until P/E10 fell below 15 instead of 10. That is, I froze the allocation during long lasting (secular) Bear Markets. I did this by modifying the P/E10 data in the Deluxe V1.1A08a calculator.

My non-stock investment was 2% TIPS.

Simple Valuation Informed Indexing Results

I set the calculator to withdraw a fixed percentage of the original balance (plus adjustments to match inflation). I determined 30-year Historical Surviving Withdrawal Rates. That is, I determined the withdrawal rates at which a portfolio would have a positive balance at Year 30 but not in Year 31. I did not assume any expenses.

I have generated a graph with my results.

VIId shows what happens if the stock allocation is 100% at low P/E10 and 0% at high P/E10 and during long lasting (secular) Bear Markets.

Simple VIId Stock Returns

This shows the Year 10 real, annualized, total returns of stocks using Simple Valuation Informed Indexing variant VIId. I have compared it with an all-stock portfolio.

Observations

VIId supports a 30-year Safe Withdrawal Rate of 5.0% (plus inflation) at today’s valuations (P/E10=17 and 100E10/P=6.0%). This compares with 4.5% with an 80% stock fixed allocation [Year 30 SWR button on left].

At Year 10, the Simple Valuation Informed Indexing variant has a 1.6% per year advantage over an all-stock portfolio.

Typically, Simple Valuation Informed Indexing requires only one or two allocation shifts in a 30 year period.

Have fun.

John Walter Russell
July 27, 2009