Author Topic: Magical thinking  (Read 5222 times)

leostrauss

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Magical thinking
« on: May 11, 2015, 06:37:16 PM »
I think there is much magical thinking going on in this forum. I look at the posts where people debate the relative merits of investing in this or that US based index and this or that bond index and roll my eyes. The obvious truth is staring everyone in the face but we pretend that the elephant in the room is not there.

We will not come even close to 4% real return on any sort of blend of US heavy stock/bonds portfolio going forward.

It is not physically possible in the long run according to any benchmark ever used to predict long term returns of a stock or a bond fund. Price to earnings is second highest in history, price to GDP is highest ever, Price to book value as well, price to sales also highest ever. Bond yields on the other hand are close to lowest ever. Hell, some developed countries hit negative bond yields in recent times.

There is no realistic scenario under which a blend of stocks and bonds that is heavily tilted to US (also applies to most other developed nations stock and bond markets) will deliver the kind of returns you people are making your life decisions on. It just won't happen.

I think the truth is that the 4% rule is dead and buried because the world is awash with cheap money being printed by lots of powerful central banks. This is probably why so many of us can now feel like being on the cusp of Financial Independence what with your "large" stash of $600K to $1M. The truth however, is that this kind of money is not even close to sufficient for early retirement if the safe withdrawal rate drops way below 4% to the more realistic 1% or 2%.

I'm not being deliberately inflammatory here. I have my life savings on the line (> $500K) which I could invest in the markets at a click of a button. But I look at all long term charts for both stocks and bonds and it's an outright disaster. It's not even in the "meh, kind of pricey" category. It's in the "holy fucking shit what have they done!" category. Look at all common metrics of the US market CAPE, P/E, P/S, P/B, MktCap/GDP. All insane.

There might be a bargain or two to be found in Russian stocks or Greek. But then one bears not just the stock market risk but the currency risk and a whole wad of political risks too. Those markets are underpriced for a reason...

seattlecyclone

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Re: Magical thinking
« Reply #1 on: May 11, 2015, 06:46:42 PM »
You're welcome to believe the next 50 years will be worse than any 50-year period in recorded history. I will disagree with you.

tj

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Re: Magical thinking
« Reply #2 on: May 11, 2015, 06:55:00 PM »
You just can't get away with saying "well, we said 4% then, but things don't look as good now as they did then." These studies incorporate periods of time back to (typically) either 1926 (CRSP data) or 1870 (CRSP supplemented by Cowles data). The claim was NOT "based on how things look in 1999, 4% should be OK." The claim was "4% includes a fat margin of safety for all economic and market conditions ever previously experienced.

Either one of two things is true:

a) Financial data is so poorly behaved, that a sample of 89 or 145 years of past data cannot yield predictions that are more reliable than "1 / chosen estimate of maximum remaining lifetime,"

b) The financial and economic outlook in the U.S. in 2015 is not just worse than 1994, it is worse than any previous time in recorded U.S. financial history since 1870. Worse than the Long Depression of 1873-96, Panic of 1907, Great Depression of 1929-1945, Great Recession of 2008-2009, worse than any of those.


My opinion is that 4% worked during the Great Depression and World War II, and 3.7% worked even during 70s where we had double-digit inflation, rising interest rates, and a stock market that went nowhere for 16 years (DOW was 1000 in 1966, and still 1000 in 1982).

So people saying that going forward we should drop to 3% or even 2.5% are basically predicting the next 20-30 years will be absolutely horrible, economically speaking... Worse than anything we've ever seen in the last 150 years.

Me, I see 1 billion Chinese and Indians joining the middle-class over the next 20 years, and all wanting to buy Cokes and washing machines.

4% wasn't generated from the good times in the past... 6% would have worked fine for many of the 30-year periods in the last 100 years... 6% may actually "probably" be safe... (i.e. more than 50% of the time, 6% works)

And on the other extreme... If 2% isn't safe, then no one is safe... If 2% doesn't work, then we're in a world where money doesn't matter (Mad Max times).

Indexer

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Re: Magical thinking
« Reply #3 on: May 11, 2015, 07:02:33 PM »
Quote from: leostrauss
We will not come even close to 4% real return on any sort of blend of US heavy stock/bonds portfolio going forward.

It is not physically possible in the long run according to any benchmark ever used to predict long term returns of a stock or a bond fund.

You are predicting long term returns and then saying it's impossible to predict long term returns. 


Quote
Look at all common metrics of the US market CAPE, P/E, P/S, P/B, MktCap/GDP. All insane.

Cape is high, but not insane.  P/E is high, but not insane.  Everything else you listed is basically meaningless crap.  I haven't seen any data that shows a strong correlation between any of those metrics and long term future returns.

So lets just focus on CAPE & PE because they have shown some correlation to future long term returns.  They are both higher than their long term averages.  They are also both WELL BELOW where they were in 2000.  Its 2015..... we didn't all die in 2000.  The world didn't end.  Y2K didn't happen.  Even if the tech bubble happened again... which it isn't... we survived the tech bubble.

Quote
But I look at all long term charts for both stocks and bonds and it's an outright disaster. It's not even in the "meh, kind of pricey" category.

What long term charts?  Those are called predictions... which you just said earlier can't be done.  Even using CAPE which is a halfway decent predictor of long term returns we will likely have low to flat returns from 2016 to 2025.  We had basically flat returns from 1999 to 2009... again... the world didn't end.

Calm down.  If you think 4% SWR isn't safe anymore aim for 3% instead, but it is not the end of the world. 

mrpercentage

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Re: Magical thinking
« Reply #4 on: May 11, 2015, 07:05:40 PM »
Do you think some of these rates reflect the change from pension to 401k investing? More people are on auto invest then ever before. More people are involved then ever before. Higher PE's of course. Most people are putting 3% or more with matched cash in the market right? I didn't look up any numbers I'm speaking from logic alone. I think most are conditioned to leave their money in now. It's one of the reasons I'm so against shorting. Big money shorting with leverage can spook investors but the numbers will continue to insanity with everyone investing their retirement. I'm talking in general of course there are always speculative plays that get out of control

Eric

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Re: Magical thinking
« Reply #5 on: May 11, 2015, 07:11:12 PM »
I'm not being deliberately inflammatory here. I have my life savings on the line (> $500K) which I could invest in the markets at a click of a button.

How is your life savings on the line if you're not currently invested?  If these are your true thoughts and you're that worried about the future, try learning about real estate investing or something else not tied directly to the stock markets.  I'm not sure how you'd sleep at night otherwise.

Probably best to just start here though:
http://www.mrmoneymustache.com/2012/10/03/the-practical-benefits-of-outrageous-optimism/


leostrauss

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Re: Magical thinking
« Reply #6 on: May 11, 2015, 07:18:03 PM »
Couple of points guys.

The 4% rule was back tested for 25-30 year withdrawals. Not for 60+ years withdrawals. Duh, if I sit in cash I can withdraw 4% for 25 years and not run out of money.

However, I think most of you assume that 4% allows one to truck along indefinitely without killing the nest egg. That I don't believe for a second is possible in this stock/bond market valuation.

Someone here dismissed Market Cap to GDP as a meaningless value. I beg to differ and so does Warren Buffett. The oracle himself stated that this is the best broad metric to judge the future performance of the market. CAPE P/E being the second one. Both scream "overvalued" from roof tops. The mess that is the bond market now does not even merit a comment.


Eric

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Re: Magical thinking
« Reply #7 on: May 11, 2015, 07:26:10 PM »
Couple of points guys.

The 4% rule was back tested for 25-30 year withdrawals. Not for 60+ years withdrawals.

Yeah, we know. 

if I sit in cash I can withdraw 4% for 25 years and not run out of money.

As long as inflation is 0%, you're golden!


However, I think most of you assume that 4% allows one to truck along indefinitely without killing the nest egg. That I don't believe for a second is possible in this stock/bond market valuation.

Yes, you mentioned this in your first post.  I'm not sure how bad things would have to get for a 1% withdrawal rate to become the new Safe Withdrawal Rate, but they would be probably so bad that I can't really even imagine.  Like bunker, guns, ammo, and MREs, type bad.  It's hardly a scenario worth preparing for.  But feel free to work an extra 30 years to assuage your fears.  No skin off my nose.

nereo

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Re: Magical thinking
« Reply #8 on: May 11, 2015, 07:28:20 PM »
I think there is much magical thinking going on in this forum. I look at the posts where people debate the relative merits of investing in this or that US based index and this or that bond index and roll my eyes. The obvious truth is staring everyone in the face but we pretend that the elephant in the room is not there.

We will not come even close to 4% real return on any sort of blend of US heavy stock/bonds portfolio going forward.
[blah blah blah]

You know, a curious pattern emerges if you start looking at financial stories going back over the last century. Without fail, every decade has brought new criticism from smart-sounding people using the latest metrics to 'prove' that returns going forward cannot equal the returns we have previously seen.  Depression in the 30s, global war in the 40s, the baby-boob in the 50s (yes, the baby-boom was considered to be an economic stranglehold when it was first observed).  In the 1960 the cold-war and near certainty that the Soviet Union was going to dominate, unsustainable spending on defense, space, you name it.  In the 1970s is was inflation and the eminent loss of the $ as the worlds de-facto currency.  1980s brought near certainty that Japan was going to surpass the US, 1990s had peak oil (again), a jobless recovery, deindustrialization. Japan, Japan, Japan.  Early 2000s had the collapse of the dot-com and the 'false economy'.  Also, the absolute certainty that China was going to surpass the US very, very soon.  It was inevitable (The Economist even did a feature on how businesses would ahve to be more 'eastern' in all apects.  Then the great recession, a jobless recover (didn't we already have one of those... sorta?)... stories about how double-digit unemployement would be the 'new normal' for a decade or more, China, China, China etc. 

...problem is, it hasn't really materialized. That's just the cliff-notes version.  I don't buy it.

forummm

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Re: Magical thinking
« Reply #9 on: May 11, 2015, 07:58:16 PM »
There are quite a few posts on the forum (even 3 threads going on currently) that discuss this very issue, along with pretty honest conversation about future returns. It turns out that a lot of us have been thinking about this and are going into our futures with open eyes. I think it's likely that returns over the next 10 years will be less than they were than they were on average for the last 100--just as they have been historically after periods of high market valuations. But that doesn't really tell us anything about the decade after that.

Life is about gathering information, making informed decisions, and then being prepared to deal with the consequences. If you think a 2% withdrawal rate is more prudent, and you'd like to expend the time to save up that much money, then that's a choice you can make. If it makes the most sense to you, then you should go with it. It's your life to live.

innerscorecard

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Re: Magical thinking
« Reply #10 on: May 11, 2015, 08:32:35 PM »
It is possible, if corporate profits stay high as a result of secular trends, such as the reduced need for labor due to automation, as well as winner-take-all scale effects that make the best corporations sustainably and extremely profitable. Whether that is likely at I don't know. But it is possible.

theoverlook

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Re: Magical thinking
« Reply #11 on: May 12, 2015, 08:02:55 AM »
Sounds to me like you got spooked.

The truth is, there's always big scary events and things are always looking like "this time it's different."  But in the end, at least so far, it has turned out that each time wasn't different.  Buy and hold and continuing to buy even through downturns has been safe for over a century.  Maybe it will fail, maybe it won't.  But if it does, what are the chances any other investment will be safe?  Cash in the bank is worthless if the bank loses its backing and the FDIC is bankrupt.  Cash on hand is worthless if nobody will take cash.  Real estate is worthless if there's no cash to pay rent.

So what's your point?  Work forever and hope they're still paying you in some sort of usable currency for your work after the shit hits the fan?  Doom and gloom is not useful without input beyond the (frankly unrealistic) predictions.

brooklynguy

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Re: Magical thinking
« Reply #12 on: May 12, 2015, 08:38:59 AM »
I think the truth is that the 4% rule is dead and buried

As explained in the responses above, there are good reasons to believe that the 4% Rule is alive and well, so you shouldn't declare it dead just yet.  But since you've already given it a premature burial, don't be surprised if you hear some knocking on the coffin--or, for a more colorful image, if you encounter a rightfully pissed-off version of the 4% Rule walking around with dirt and splinters under its fingernails and a fresh (and understandable) case of taphophobia.

However, I think most of you assume that 4% allows one to truck along indefinitely without killing the nest egg.

If anything, I think most people here have the opposite problem.  All of the responses so far describe only why the 4% Rule, as a historical-worst-case-derived rule of thumb, may have sufficient built-in safety to survive most any market conditions.  But most of us go much further than relying on the inherent safety in our chosen withdrawal plan, building in layer upon layer of external levels of safety margin.  To name but a few:  flexibility to cut spending; flexibility to supplement income; discounting (or totally ignoring) social security benefits and potential inheritances; etc. etc. etc.  So, when we start off using a rule of thumb designed to withstand the strongest headwinds like a rigid oak, but then in practice bend with the wind like a flexible reed, I'd say we are very likely to succeed.

sheepstache

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Re: Magical thinking
« Reply #13 on: May 12, 2015, 09:05:17 AM »


However, I think most of you assume that 4% allows one to truck along indefinitely without killing the nest egg. That I don't believe for a second is possible in this stock/bond market valuation.


I'm sure one of the 4% police will correct me if I'm wrong, but I thought the 4% strategy had no such assumption that the principal would go untouched. If you run your scenario and end up with 0 dollars the day after you die, that's considered a success.

matchewed

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Re: Magical thinking
« Reply #14 on: May 12, 2015, 09:09:50 AM »


However, I think most of you assume that 4% allows one to truck along indefinitely without killing the nest egg. That I don't believe for a second is possible in this stock/bond market valuation.


I'm sure one of the 4% police will correct me if I'm wrong, but I thought the 4% strategy had no such assumption that the principal would go untouched. If you run your scenario and end up with 0 dollars the day after you die, that's considered a success.

You are correct. There is nothing in the Trinity Study nor in the assumptions which govern the 4% rule that state "Thou shalt not touch principal." In fact if you think about it nearly any 30 year period would have you dip into principal at least once. It is more critical on the when it happens, not the if it happens (because for one thing the if is practically guaranteed).

nereo

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Re: Magical thinking
« Reply #15 on: May 12, 2015, 09:23:54 AM »
I think the truth is that the 4% rule is dead and buried

As explained in the responses above, there are good reasons to believe that the 4% Rule is alive and well, so you shouldn't declare it dead just yet.  But since you've already given it a premature burial, don't be surprised if you hear some knocking on the coffin--or, for a more colorful image, if you encounter a rightfully pissed-off version of the 4% Rule walking around with dirt and splinters under its fingernails and a fresh (and understandable) case of taphophobia.
Lol - I had to look up taphophobia.
But seriously, the "4% rule" didn't come about until 1994, but people have been declaring it 'dead' since it first came alive.  Even before it was 'born' there has been a steady stream of news articles declaring that everything from 'buy-and-hold is dead' to 'the easy money is behind us'.

For example - under "4% rule is dead"
2015 http://www.benefitspro.com/2015/04/15/time-to-kill-the-4-percent-rule
2014 (CNBC) http://www.cnbc.com/id/102082938
2013 (wall street journal) - http://www.wsj.com/articles/SB10001424127887324162304578304491492559684
2012 (Marketwatch) http://www.marketwatch.com/story/say-goodbye-to-the-4-rule-2012-11-13
2011 (Forbes) http://www.forbes.com/sites/thebogleheadsview/2011/03/29/how-to-retire-early-plan/
2010  (Marketwatch) http://www.marketwatch.com/story/time-to-replace-the-4-withdrawal-rule-2010-04-22
2009 (Barron's) http://online.barrons.com/articles/SB125694285397619649?tesla=y

Ironically, this time period has been one of the greatest 6 year bull markets of all time.  This isn't to say that the next few decades won't have sub-par performance - just that the inevitable doom-and-gloom around the 4% rule has been ongoing and, so far, hasn't proved accurate.
Now, as brooklynguy pointed out, most people around here aren't going into the future blind and assuming the past will = the future.  If anything, I see people being overly conservative.  We talk of moving to lower COL areas.  We overestimate the amount we think we will need in ER.  We assume we will never earn another $ ever again, and that we will be unable to get a job at any salary, anywhere.  We talk about how we can continue to optimize expenses.  We obsess about the most tax-efficient strategies (which we rarely incorporate into our annual expenses category).  SS is routinely ignored.  One of my biggest frustrations is seeing people who hate their job but fall victim to OMY even with layer-upon-layer of security over the so-called '4% rule'.

adamwoods137

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Re: Magical thinking
« Reply #16 on: May 12, 2015, 10:09:46 AM »
A few bullets:

  • Even if US markets are overvalued by CAPE, that doesn't mean world markets are.
  • Just because Warren Buffet thinks market cap to GDP doesn't mean it is. If you trust him with your financial future buy Berkshire Hathaway, he literally just said it was fairly valued.  Otherwise explain why market cap to GDP should be mean reverting, and why GDP won't increase instead.
  • If you're going to use CAPE as a valuation metric buy Russia and Greece.  You can't say out of one side of your mouth CAPE says US is overvalued therefore future returns will be poor, despite all of the good things the US has going for it compared to any other time in history. Then out of the other side say that CAPE says Greece is undervalued by returns will be poor, because of all the bad things Greece has going against it.  Things are never cheap for the fun of it! At least you know why Greece is cheap, that's much better than the CAPE being low and you scratching your head.
  • You are right that looking at historical data in the US and basing a retirement off of it is probably a bad idea.  The US was an exceptional market over the last 120 years. (Compare to Italy for example).
  • Why are you in cash if you think the market is get 4% per annum?
  • Saying something isn't physically possible is entertaining for cartoon villains, but keep their fates in mind. Everything in finance is physically possible, what you should be worried about is what's financially likely.  The only thing that seems to be a lock certainty is that you're wrong about something. The most productive use of your energy will probably be figuring out what that is.

Disclosure - Long GREK leaps, Long BRK