Switching Safe Withdrawal Rates 1.8% TIPS
I have collected Safe Withdrawal Rate data for switching with TIPS at a 1.8% interest rate. Previously, I had used an interest rate of 2.0%. This lets us know the effect that reducing the interest rate has on Safe Withdrawal Rates.
Historical Surviving Withdrawal Rates
I started with the optimized four threshold, five allocation (with three adjustable allocations) switching algorithm. The P/E10 thresholds are 9-12-21-24. The allocations are 100%-50%-30%-20%-0%. That is, when P/E10 is below 9, the stock allocation is 100%. When the P/E10 is between 9 and 12, the stock allocation is 50%.
[P/E10 is the latest index level (or price) of the S&P500 index divided by the average of the previous ten-years of earnings. Professor Robert Shiller developed this indicator and he has shown that P/E10 has predictive power over the intermediate-term (10 years). It has been our most successful measure of valuations for calculating Safe Withdrawal Rates so far. The calculator uses the January values for each year.]
I used my Deluxe Calculator V1.1A08. I set expenses equal to 0.20%. I adjusted withdrawals to match inflation in accordance with the CPI. I set the TIPS interest rate at 1.8%. I set the desired lifespan of the portfolio at 30 years.
I increased withdrawal rates in increments of 0.1%. I recorded Historical Surviving Withdrawal Rates. They are the highest rates with a positive balance at year 30. When the withdrawal rate is increased by 0.1%, the balance at year 30 is zero or negative.
I collected a complete set of Historical Surviving Withdrawal Rates from 1871-1980.
Formulas
I plotted Historical Surviving Withdrawal Rates versus the percentage earnings yield 100E10/P (or 100% / [P/E10] ). I used Excel’s curve fitting capability to fit straight lines to the data and report the equations (i.e., regression equations) and goodness of fit (R-squared). I used eyeball estimates to set my confidence limits as a matter of convenience. [There are formulas to generate more accurate numbers, but they are time consuming.]
Using the 1923-1980 data, the old formula using 2.0% TIPS for the Calculated Rate was:y = 0.3276x+3.9729. R-squared is 0.5815. My eyeball estimates of the confidence limits were plus 1.3% and minus 0.7%. [I place my greatest emphasis on data with earnings yields of 10% and lower.]
Using the 1923-1980 data, the new formula using 1.8% TIPS for the Calculated Rate is:y = 0.3222x+3.9251. R-squared is 0.5796. My eyeball estimates of the confidence limits are plus 1.4% and minus 0.8%. [I place my greatest emphasis on data with earnings yields of 10% and lower.]
Valuations
Here are the January values of P/E10 throughout the last decade.
1995 20.22
1996 24.76
1997 28.33
1998 32.86
1999 40.58
2000 43.77
2001 36.98
2002 30.28
2003 22.89
2004 27.65
Today: use an earnings yield of 3.5%.
Old Calculations
Here are the Safe, Calculated and High Risk Rates of the last decade with Switching with 2% TIPS.
Year, Safe Withdrawal Rate, Calculated Rate, High Risk Rate
1995…..4.9….5.59….6.9
1996…..4.6….5.30….6.6
1997…..4.4….5.13….6.4
1998…..4.3….4.97….6.3
1999…..4.1….4.78….6.1
2000…..4.0….4.72….6.0
2001…..4.2….4.86….6.2
2002…..4.4….5.05….6.4
2003.….4.7….5.40….6.7
2004…..4.5….5.16….6.5
Today..4.4….5.12….6.4
New Calculations
Here are the Safe, Calculated and High Risk Rates of the last decade with Switching with 1.8% TIPS.
Year, Safe Withdrawal Rate, Calculated Rate, High Risk Rate
1995…..4.7….5.52….6.9
1996…..4.4….5.23….6.6
1997.….4.3….5.06….6.5
1998.….4.1….4.91….6.3
1999.….3.9….4.72….6.1
2000.….3.9….4.66….6.1
2001…..4.0….4.80….6.2
2002…..4.2….4.99….6.4
2003…..4.5….5.33….6.7
2004…..4.3….5.09….6.5
Today..4.3….5.05….6.5
Summary
Today’s Safe Withdrawal Rate fell from 4.4% using 2.0% TIPS to 4.3% using 1.8% TIPS. Today’s Calculated Rate is 5.05% with 1.8%. Previously, it was 4.12% with 2.0% TIPS. Today’s High Risk Rate is 6.5% with 1.8% TIPS. Previously, it was 6.4% with 2.0% TIPS.
What we are seeing is primarily caused by differences in my eyeball estimates of the scatter (i.e., the width of the confidence intervals). The Calculated Rates differ only by 0.07%.
Have fun.
John Walter Russell
I wrote this on June 16, 2005.
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