Simple Valuation Informed Indexing

Valuation Informed Indexing offers an advantage over buy and hold. Here is what a simple variant delivers in terms of Safe Withdrawal Rates. Typically, you make only one or two allocation shifts in a 30 year period.

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 mostly out of stocks until P/E10 fell below 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 graphs with my results.

VIIa is 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.

VIIb is what happens if the stock allocation is 100% at low P/E10 and 20% at high P/E10 and during long lasting (secular) Bear Markets.

VIIc is what happens if the stock allocation is 80% at low P/E10 and 20% at high P/E10 and during long lasting (secular) Bear Markets.

Observations

VIIa and VIIb support a Safe Withdrawal Rate of 6% (plus inflation) at today’s valuations (P/E10=17 and 100E10/P=6.0%). Reducing the stock allocation to 80% during Bull Market run ups still allows you to withdraw 5.8% (plus inflation).

There is a danger with Simple Valuation Informed Indexing that you exclude yourself from the stock market for very long periods of time. This happened with the 1976 and 1977 sequences (100E10/P=9% and HSWR=6%+). That explains these two outliers. In reality, fixed income investments did considerably better than 2% TIPS during those years.

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

Have fun.

John Walter Russell
July 26, 2009