Waiting for the Big Drop

I tried to reach a 5% withdrawal rate with a conventional withdrawal strategy, one that includes selling shares. This time I limited my stock allocation to 50% unless I encountered a big drop: 10% of the original balance (plus inflation).

Once again, I failed.

Conditions

I started with a $100000. I withdrew $5000 (plus inflation). I used the Scenario Surfer. I adjusted withdrawals in accordance with valuations. I used TIPS with a 2% interest rate.

The stock holding in the Scenario Surfer is based on the S&P500 index.

My minimum stock allocation was 20%. Until my balance fell $10000 (plus inflation), I limited my maximum stock allocation to 50%. After a big drop, my maximum stock allocation was 100%.

Results

I used 20% to 50% stock allocations until a $10000 drop, then I allocated up to 100%. I withdrew $5000 per year (plus inflation).

Run 1:
Final balance: 9,830
The 20%, 50% and 80% rebalancing portfolios went bankrupt.

Run 2:
Final balance: 36,801
The 20% and 50% rebalancing portfolios went bankrupt.
With 80% rebalancing: 2,838

Run 3:
Final balance: 48,692
The 20%, 50% and 80% rebalancing portfolios went bankrupt.

Run 4:
Never fell by $10000.
Final balance: bankrupt.
The 20% and 50% rebalancing portfolios went bankrupt.
With 80% rebalancing: 18,107

Run 5:
Final balance: bankrupt.
The 20%, 50% and 80% rebalancing portfolios went bankrupt.

Summary

I was unable to reach a 5% (plus inflation) withdrawal rate using a conventional strategy starting from P/E10=26. On the other hand, reaching 4.5% is simple and straightforward so long as we vary allocations in accordance with valuations.

There is a big payoff in being able to increase the stock allocation to 100% when P/E10 is at bargain levels. That is one reason that varying allocations is so much better than fixed allocations.

There is always the danger of a sharp drop in stock prices when starting from today’s valuations. But, as indicated by Run 4, a sharp enough drop may fail to materialize.

Have fun.

John Walter Russell
December 12, 2007