Author Topic: Doubting the stock market  (Read 24320 times)

Allen

  • Stubble
  • **
  • Posts: 246
Doubting the stock market
« on: January 26, 2014, 08:23:43 PM »
I'm VERY risk tolerant, and I have seen my portfolio drop 30%+ twice in my investing life, while continuing to stay 100% invested in the stock market. 

However, I'm doubting the 4% rule going forward.  This obviously worked in the past, it SHOULD work in the future but the major difference between then (1871 to 1980) and now is the P/E of the stock market is historically above the average.  Also, with interest rates kept abnormally low with the massive $$$ being pumped in, it seems that stock are being kept artificially high.  This seems to make the stock market much more risky than normal.

Am I being reasonable?  I'm not sure what my alternatives would be.  Should I just keep pumping money in and dollar cost averaging and reinvesting dividends?

bk1

  • 5 O'Clock Shadow
  • *
  • Posts: 13
Re: Doubting the stock market
« Reply #1 on: January 26, 2014, 08:54:19 PM »
I struggle with this as well. I know historically what the stock market has done. However, never before have we been running this kind of debt totals as a country with no end in sight. Also, the fed buying up all this debt just doesn't seem right as they pretty much create the funds to buy the debt from nothing.

The whole stock market seems kind of like a big casino sometimes. You can bet this will go up, or bet that will go down. It seems like a game that we are almost forced to play.

At this point, I'm playing the game because although the game seems rigged, it's the only game in town.

mom2_3Hs

  • 5 O'Clock Shadow
  • *
  • Posts: 58
Re: Doubting the stock market
« Reply #2 on: January 26, 2014, 10:21:25 PM »
What do you have in real estate?  We own a multi-unit home; we live in one part, and rent out part.  As long as you can keep stable tenants and don't get in an overvalued area, it seems like an inflation-resistant investment and less susceptible to the whims of the stock market.

dmn

  • Stubble
  • **
  • Posts: 101
  • Location: Switzerland
Re: Doubting the stock market
« Reply #3 on: January 27, 2014, 02:24:33 AM »
However, I'm doubting the 4% rule going forward.  This obviously worked in the past, it SHOULD work in the future but the major difference between then (1871 to 1980) and now is the P/E of the stock market is historically above the average.

In principle, that should result in lower-than-average future returns. In the current environment, I'd rather use a 3% withdrawal rate.

However, choosing the withdrawal rate only becomes important when deciding to retire - in the accumulation phase, you can just keep buying assets according to your asset allocation. Stocks are not clearly overvalued when compared to other assets - bond yields are also low, and in many areas rental yields from real estate are depressed as well.

aclarridge

  • Guest
Re: Doubting the stock market
« Reply #4 on: January 27, 2014, 09:05:58 AM »
Yeah, other countries' stock markets have not kept pace with American indices historically. Things change. Americans may find themselves in a low growth environment compared to other countries in the future. I think the 4% rule is a general guideline and not to be followed so strictly - have a hobby that earns some money, get a skill that saves you money, and generally live on a bit less than 4% of your stash. MMM did a nice article on the levels of safety in his life.

thepokercab

  • Bristles
  • ***
  • Posts: 486
Re: Doubting the stock market
« Reply #5 on: January 27, 2014, 09:10:42 AM »
Quote
I think the 4% rule is a general guideline and not to be followed so strictly - have a hobby that earns some money, get a skill that saves you money, and generally live on a bit less than 4% of your stash. MMM did a nice article on the levels of safety in his life.

+1

Exactly how I think about the 4% rule.  A general bench mark, and a goal of mine to be sure, but not something that I would etch in stone in terms of my FIRE plan.

Here's that MMM post on safety margins:

http://www.mrmoneymustache.com/2011/10/17/its-all-about-the-safety-margin/

Allen

  • Stubble
  • **
  • Posts: 246
Re: Doubting the stock market
« Reply #6 on: January 27, 2014, 11:31:45 AM »
What do you have in real estate?  We own a multi-unit home; we live in one part, and rent out part.  As long as you can keep stable tenants and don't get in an overvalued area, it seems like an inflation-resistant investment and less susceptible to the whims of the stock market.

Real Estate is an area I'm not particularly comfortable with, I'm not particularly handy, I don't particularly understand construction or the market values, and because of my ignorance I mostly avoid it.  I have no real estate exposure other than my house.  This is a key area I want to learn more about.

matchewed

  • Magnum Stache
  • ******
  • Posts: 4334
  • Location: CT
Re: Doubting the stock market
« Reply #7 on: January 27, 2014, 12:08:54 PM »
You don't sound very risk tolerant. :) The moment you start losing sleep over your AA then you should revisit it and make sure it is right for you. If you're worried adjust something, increase your position in something that reduces that volatility you're worried about.

If you're okay with the volatility then just use a different SWR. 3% would be fairly conservative and just mean a slightly larger stash depending on your expenses. Or as others have stated you rely on your gumption and flexibility to make up that 1%.

Allen

  • Stubble
  • **
  • Posts: 246
Re: Doubting the stock market
« Reply #8 on: January 27, 2014, 01:36:35 PM »
I'm risk tolerant about large swings and volatility and losing money.  My concern is that the future returns may no longer justify being on the ride at all as it has in the past. 

I'm not changing anything though, still 100% stocks / index funds and all monthly savings going into stocks.  Perhaps that is stupid?  I could probably use some help on a 'better' asset allocation.

matchewed

  • Magnum Stache
  • ******
  • Posts: 4334
  • Location: CT
Re: Doubting the stock market
« Reply #9 on: January 27, 2014, 01:50:56 PM »
Well if you don't feel that future returns aren't justifiable then why stay in stocks at all? If you feel comfortable for wealth generation then why are they no good for further wealth generation?

Also are you coming at this from your gut or your head? Sure even the head says that past performance is not indicative of future returns, but every investment has that same caveat, it is not unique to stocks.

nawhite

  • Handlebar Stache
  • *****
  • Posts: 1060
  • Location: An RV somewhere in the West
    • The Reckless Choice
Re: Doubting the stock market
« Reply #10 on: January 27, 2014, 04:43:40 PM »
One of the best active researchers about the safe withdrawal rate is Dr. Wade Pfau. He has a blog which has some really good gems explaining some of the intricacies of the "4% rule" and what impacts it. One of my favorites is a short post: http://wpfau.blogspot.com/2013/09/lifetime-sequence-of-returns-risk.html (the returns of the stock market the first year you retire matter more to your safe withdrawal rate than any other year)

He has a whole lot of peer-reviewed papers about the 4% rule and retiring in general. One of his recent "famous" ones is http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2201323

In that paper, he argues that while historically the 4% rule resulted in failure 6% of the time, today's lower return years could push that failure rate for the 4% rule up to 57% for new retirees.

Your mileage may vary. The trick as others have said is that its all about the safety margins. Look at your personal assets (both financial capital and human capital). Paid off houses can be huge "retirement-savers." So can rental real estate. So can family inheritances. So can Social Security. So can part time work. So can the fact that you can spend less in down years if you need to.

If you plan to retire for 30 years exactly and then die, and you wont have any other income sources in retirement, and you will spend the same amount (inflation adjusted) every single year of your retirement, THEN the 4% rule may not work for you anymore. Those were the assumptions of the original research which came up with the 4% rule and for most of Dr. Pfau's new research. If those assumptions don't apply to you (they don't for anyone who retires in America b/c of Social Security at least) then adjust your withdrawal rate accordingly.

nawhite

  • Handlebar Stache
  • *****
  • Posts: 1060
  • Location: An RV somewhere in the West
    • The Reckless Choice
Re: Doubting the stock market
« Reply #11 on: January 27, 2014, 04:55:51 PM »
Forgot to mention the most comprehensive explanation and history of the 4% rule anywhere: http://financialmentor.com/free-articles/retirement-planning/how-much-to-retire/are-safe-withdrawal-rates-really-safe

He comes to the conclusion that 4% is too high. I read all of his data and come to the conclusion that 4% is too low. For me its because even if I had 0% real returns in a savings account, 4% (plus a super cheap paid off house) lasts me 25 years. Within 25 years of retiring, most people will be able to start to collect Social Security. Social Security (even at 60% of what the calculators say I should get) is enough for me to "succeed" at retirement if I have a paid off house. It wouldn't be fun and I wouldn't be doing international travel, but when that is the absolute worst case scenario, I stop worrying.

Add to that the fact that I'll probably be working part time on fun things I want to do for many years and I can decrease my spending in years the stock market is down (or go back to work if it tanks the year I retire), and 4% seems awfully conservative to me.

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 28029
  • Age: -999
  • Location: Seattle, WA
Re: Doubting the stock market
« Reply #12 on: January 27, 2014, 05:24:59 PM »
However, I'm doubting the 4% rule going forward.  This obviously worked in the past, it SHOULD work in the future but the major difference between then (1871 to 1980) and now is the P/E of the stock market is historically above the average.

Wasn't the P/E historically above its average about half the time? (I know, median versus mean, but approximately - you see my point.)

And then when you add in that 4% was just about the worst case historically here (and many other times supported a higher SWR)...

I don't see much cause for worry.  For a very long ER, I'd shoot for closer to 3%, but that's cause I'm quite conservative in many ways.

The stock market being "high" in relation to the 4% rule is not something to be concerned about though, IMO, once you understand where the 4% rule came from.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

mpbaker22

  • Handlebar Stache
  • *****
  • Posts: 1095
Re: Doubting the stock market
« Reply #13 on: January 28, 2014, 07:27:41 AM »
The 4% rule is a very popular rule of thumb and I think it was first proposed by a financial planner back in 1994 using data back to 1969.  Back then interest rates were much higher than today (7ish percent I think).  It also assumed you were going to need to live off of your savings for 30 years.

It’s probably as good as any other rule of thumb but I wouldn’t stake my future retirement comfort on it.  First of all interest rates are much lower now so they can’t support a 4% withdrawal rate.  Second, the longer you need to live off the funds, the lower the withdrawal rate it can support.  Third, I see some people adding up living expenses, multiplying by 25 and using that as a target,  That’s fine as long as you don’t pay any income taxes on withdrawals.  If you do, you need to gross up your expenses for taxes before applying the multiplier. Forth, I don’t like the fact that there is no discussion about future inflation.  If inflation spikes (seems doubtful now but…) then you will have to increase withdrawal rates or suffer a decline in living standards.  Finally, don’t forget to consider big ticket purchases that don’t occur every year.  For example, if you buy a $50,000 car every 10 years, include $5,000 of expenses annually.

This is what I do:  Gross up my annual living expenses by 10% to allow for big ticket purchases then by another 30% to account for taxes (about a 23% tax rate on dividends and capital gains). I take that and divide it by 4% to get my target retirement savings amount.  My logic for using a 4% discount rate is that the stock portfolio I own has a 4% dividend yield.  That allows any capital gains to offset inflation and pay for unforeseen expenses.  Net that works out to a 2.8% discount rate on my annual living expenses.  I think I’m being very conservative but I can sleep at night with this.

If you invest in a portfolio that includes bonds, I would multiply the 4% by the proportion of your portfolio in stocks.  For example if you have 60% in stocks your discount rate should be 2.4% (4% x 60%).  To me, bonds at best will keep up with inflation.  The capital losses on any long-term bond portfolio if rates go up will be hard to overcome.  I don’t own a single bond or bond like investment.

These are my thoughts.  Everyone should do their own work and analysis before deciding on how to define their retirement goals and portfolio investments.

no ... just no.

I think I'm done responding to these ridiculous posts.  Ridiculous parts in bold.


iamlindoro

  • Handlebar Stache
  • *****
  • Posts: 1520
    • The Earth Awaits
Re: Doubting the stock market
« Reply #14 on: January 28, 2014, 07:33:14 AM »
The 4% rule is a very popular rule of thumb and I think it was first proposed by a financial planner back in 1994 using data back to 1969.  Back then interest rates were much higher than today (7ish percent I think).  It also assumed you were going to need to live off of your savings for 30 years.

I don't mean to call you out, but literally everything about this is incorrect.  The study was done by finance professors, not financial planners, in 1998 (and updated in 2009), not 1994, using data going back to 1925.  It also has nothing to do with interest rates as it concerns itself only with stocks.

Basically, the 4% rule is as close to a sure thing as it gets in investment.  It's vetted against broad and recent data by objective parties.

http://en.wikipedia.org/wiki/Trinity_study

mpbaker22

  • Handlebar Stache
  • *****
  • Posts: 1095
Re: Doubting the stock market
« Reply #15 on: January 28, 2014, 07:53:30 AM »
The 4% rule is a very popular rule of thumb and I think it was first proposed by a financial planner back in 1994 using data back to 1969.  Back then interest rates were much higher than today (7ish percent I think).  It also assumed you were going to need to live off of your savings for 30 years.

I don't mean to call you out, but literally everything about this is incorrect.  The study was done by finance professors, not financial planners, in 1998 (and updated in 2009), not 1994, using data going back to 1925.  It also has nothing to do with interest rates as it concerns itself only with stocks.

Basically, the 4% rule is as close to a sure thing as it gets in investment.  It's vetted against broad and recent data by objective parties.

http://en.wikipedia.org/wiki/Trinity_study

Not to mention there have been literally hundreds of threads (plus the MMM article itself) where posters have mentioned that 4% is not that safe, but 3.5% and certainly 3%, are.

jaivee

  • Guest
Re: Doubting the stock market
« Reply #16 on: January 28, 2014, 08:11:08 AM »
First of all, I don't understand why what I am saying is wrong.  You may disagree but as I clearly state "I think I'm being very conservative" and "these are my thoughts".  I think everyone is entitled to their own opinion.  Studies like these are interesting, but they are based on historical data and one thing I can guarantee is that history will never be exactly repeated.

When adding up living expenses, you have to include income taxes expected to paid on your investment portfolio because that is an actual expense that is unavoidable.  All the studies I've read about withdrawal rates all assumed that withdrawals were indexed to inflation so I don't understand how a spike in inflation would not be detrimental to this plan.  And bonds to me are good for reducing volatility but they are not going to provide any real rate of return for the foreseeable future.  If rates stay flat you'll collect your coupon, if rates go up the value of your bond goes down.  If you hold to maturity you get back the $100 principle which is great if you paid $100 for the bond, if you paid a premium (above face value) you lose.  I'd like to hear other opinions, I'm trying to learn here too.

Regarding whether or not the Trinity study concerned itself with just stocks or a mix please see the post you referred me to which states "The context is one of annual withdrawals from a retirement portfolio containing a mix of stocks and bonds."
Regarding my comment about who initially did the study please see http://en.wikipedia.org/wiki/William_Bengen and http://www.cnbc.com/id/101103023 I'm just posting what I'm reading. If it's wrong, sorry.

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 28029
  • Age: -999
  • Location: Seattle, WA
Re: Doubting the stock market
« Reply #17 on: January 28, 2014, 08:19:12 AM »
First of all, I don't understand why what I am saying is wrong.

Because you clearly haven't read or understood the research around the Trinity study.

You state multiple incorrect things as facts.  (One example: your talk of inflation, as if that wasn't taken into account.  Another is that the Trinity study used a mix of 60/40 stocks/bonds and, since it was looking at historical data, the interest rate of 7% at the time of the study is completely irrelevant. It could have been 0%, or 100%, and not affected the study one bit because it was looking at historical data, not making predictions based on the current environment.)

What you are saying is wrong because you are saying incorrect things.

But you do say them with confidence.  ;)
« Last Edit: January 28, 2014, 08:21:36 AM by arebelspy »
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

mpbaker22

  • Handlebar Stache
  • *****
  • Posts: 1095
Re: Doubting the stock market
« Reply #18 on: January 28, 2014, 09:17:50 AM »
First of all, I don't understand why what I am saying is wrong.  You may disagree but as I clearly state "I think I'm being very conservative" and "these are my thoughts".  I think everyone is entitled to their own opinion.  Studies like these are interesting, but they are based on historical data and one thing I can guarantee is that history will never be exactly repeated.

When adding up living expenses, you have to include income taxes expected to paid on your investment portfolio because that is an actual expense that is unavoidable.  All the studies I've read about withdrawal rates all assumed that withdrawals were indexed to inflation so I don't understand how a spike in inflation would not be detrimental to this plan.  And bonds to me are good for reducing volatility but they are not going to provide any real rate of return for the foreseeable future.  If rates stay flat you'll collect your coupon, if rates go up the value of your bond goes down.  If you hold to maturity you get back the $100 principle which is great if you paid $100 for the bond, if you paid a premium (above face value) you lose.  I'd like to hear other opinions, I'm trying to learn here too.

Regarding whether or not the Trinity study concerned itself with just stocks or a mix please see the post you referred me to which states "The context is one of annual withdrawals from a retirement portfolio containing a mix of stocks and bonds."
Regarding my comment about who initially did the study please see http://en.wikipedia.org/wiki/William_Bengen and http://www.cnbc.com/id/101103023 I'm just posting what I'm reading. If it's wrong, sorry.

You are entitled to your own opinion, but not your own facts.  People on this board always bring up taxes when talking about SWRs.  Most people treat them as an expense.  Also, your estimate of tax brackets is completely unreasonable for most people on this board.  I don't understand where you got 23%, but capital gains taxes max out at 20% but that's only for someone making MORE than 400K/year.  Dividends are taxed at a much higher rate, but they don't even get above 20% until a family's income reaches over 60K.  In short, I reject your 23% assumption.

You mention inflation, which is ridiculous as ARebelSpy pointed out.

Your 10% rule is also ridiculous for those who have already planned for them.  I guess you just think we're all so stupid we can't actually plan for expenses?  I doubt there's a single person on here that is going to buy a $50,000 car ever, even after inflation.

Edited - as pointed out below, this was clearly incorrect.  In fact, I'll probably buy a car at $50,000 if inflation holds around 3% and I live to be 80+
« Last Edit: January 28, 2014, 11:21:38 AM by mpbaker22 »

gecko10x

  • Bristles
  • ***
  • Posts: 420
    • SawyerPF
Re: Doubting the stock market
« Reply #19 on: January 28, 2014, 10:44:55 AM »
  I doubt there's a single person on here that is going to buy a $50,000 car ever, even after inflation.

While I agree with everything else you wrote, just thought I'd point out that $20k @ 3% inflation for 30 years is $50k. There are plenty of people on the board that buy new and drive 10+ years, so I don't think this is out of the realm of possibility.

Just nit-picking though ;-)

jaivee

  • Guest
Re: Doubting the stock market
« Reply #20 on: January 28, 2014, 11:41:45 AM »
arebelspy:   Thanks for your comments.  I have to respect the fact that you are a Global Moderator and a Senior Mustachian with 6394 posts.  I am happy for the opportunity to add to my 3 posts.  I have read the Trinity Study.  While I am not saying that it’s not possible that I don’t understand it (there are many things that I don’t understand which is why I am happy to be engaged in this great forum), I think the fact that I am a Chartered Financial Analyst with a BA in Economics and 20 years of finance industry experience makes my opinion and interpretation of these studies at least a little bit credible.  As for my statement of facts: my opening paragraph says “I think”.my closing paragraph says “these are my thoughts”.  The things I state as facts:  “interest rates are much lower now so they can’t support a 4% withdrawal rate” – I regret that one.  I should have said they are less likely to support a 4% withdrawal rate.  That is obvious so sorry for that one.  If inflation spikes (seems doubtful now but…) then you will have to increase your withdrawal rate or suffer a decline in living standards” I think this is a fact, maybe your definition of inflation spike differs from mine.  The Trinity authors even touch on this: “We found that all but 1 of the 18 failing portfolios spanned the high-inflation years of the late 1970s. As the withdrawals were adjusted upward as a result of high inflation and low financial market returns, the portfolios were depleted and failed. Thus, as in the analysis of 7 percent fixed withdrawals, extraordinary economic and financial circumstances explain the failures of the 5 percent inflation-adjusted withdrawals from 50 percent stock and 50 percent bond portfolios. As equivalent circumstances develop, clients have little choice but to reduce planned withdrawals in order to preserve their portfolios.” I also said “The capital losses on any long-term portfolio if rates go up will be hard to overcome.” That’s math but I guess I should have said “I think it will be hard to overcome”.  Finally I said what I did to arrive at my own withdrawal rate – that’s my own process that I used to come up with a withdrawal rate looking forward that I think is reasonable for me, not based on a study of the past.  Your point about the 7% interest rates at the time of the study is very valid.  I didn’t express myself clearly.  The 30 year periods that the revised Trinity study looks at began in 1926 and the last 30 year period began in 1981.  For most of that period the US was on the gold standard so I think inflation and interest rates were pretty tame.  In the 70’s when the gold standard was abandoned, inflation and interest rates spiked.  That is also the period where the Trinity study saw portfolios failing.  After the spike, I think in the early 80s bond yields fell from mid-teens to where we are today around 2-3%.  This drop in yields provided a huge boost to both bond returns and equity returns.  Something that I don’t think can happen going forward given our starting point today.  I think we are all trying to use their historical analysis to try to make a prediction about whether or not our nest egg can support our lifestyle in the future.  So I’m saying use their results with caution.  Again – I came up with my own way to figure out my own withdrawal rate based on what I think will happen going forward, and I shared it with the forum.
Mpbaker22: Thank you as well, I see that you are also a Senior Mustachian.  I am not saying that no one treats them as an expense.  That post I initiall put up was actually part of an email I sent my brother in response to a question he sent me on this topic. He hadn’t included taxes in his calculations.  I understand that you and many people on this forum are more knowledgeable of this process, but I have seen some spreadsheets that didn’t account for taxes.  I was just bringing it up in the hopes that others wouldn’t make that mistake.  My tax bracket is based on my actual taxes paid.  I’m in Canada, maybe that explains the discrepancy.  I’ve already talked about inflation above. Referring to this article by the Trinity authors http://www.fpanet.org/journal/CurrentIssue/TableofContents/PortfolioSuccessRates/  .  My comment about a $50k car was not meant to suggest that people should buy $50k cars or that they will ever buy a $50k car.  It was just an example of a large expenditure.  I could have said a $10k roof replacement or a $20k car.  The item wasn’t the point the point was the unexpected expenditure.  The large expenditures suggestion is probably stupid for someone like you who is very knowledgeable but again, it’s similar to my comment about taxes.  Just meant it as a word of caution, not meant to insult the intelligence of anyone on this forum.  My comment about a $50k car was not meant to suggest that people should buy $50k cars or that they will ever buy a $50k car.  It was just an example of a large expenditure.  I could have said a $10k roof replacement or a $20k car.  The item wasn’t the point the point was the unexpected expenditure.

Poorman

  • Bristles
  • ***
  • Posts: 260
  • Age: 41
  • Location: Orange County, CA
Re: Doubting the stock market
« Reply #21 on: January 28, 2014, 11:42:08 AM »
However, I'm doubting the 4% rule going forward.  This obviously worked in the past, it SHOULD work in the future but the major difference between then (1871 to 1980) and now is the P/E of the stock market is historically above the average.

Wasn't the P/E historically above its average about half the time? (I know, median versus mean, but approximately - you see my point.)


By some measurements, the P/E for stocks is grossly out of line with historical averages.  The Shiller PE, which normalizes for business cycles, shows that the only years stocks have been valued higher are 1929, 1999-2000, and the 3-4 years prior to the financial collapse in 2008.

http://www.gurufocus.com/shiller-PE.php

Shiller created this measurement to gauge the implied return of the S&P going forward.  At today's valuation, it implies a return of 1.4%.

daverobev

  • Magnum Stache
  • ******
  • Posts: 3384
  • Location: France
Re: Doubting the stock market
« Reply #22 on: January 28, 2014, 12:27:33 PM »
Dear jaivee,

please find enclosed your 'enter' key. We apologies that it did not arrive with your new computer. Don't be afraid to put it to good use; we have factory tested it up to one hundred thousand key presses!

Sincerely,

PC Manufacturing Co Ltd

arebelspy:   Thanks for your comments.  I have to respect the fact that you are a Global Moderator and a Senior Mustachian with 6394 posts.  I am happy for the opportunity to add to my 3 posts.  I have read the Trinity Study.  While I am not saying that it’s not possible that I don’t understand it (there are many things that I don’t understand which is why I am happy to be engaged in this great forum), I think the fact that I am a Chartered Financial Analyst with a BA in Economics and 20 years of finance industry experience makes my opinion and interpretation of these studies at least a little bit credible.  As for my statement of facts: my opening paragraph says “I think”.my closing paragraph says “these are my thoughts”.  The things I state as facts:  “interest rates are much lower now so they can’t support a 4% withdrawal rate” – I regret that one.  I should have said they are less likely to support a 4% withdrawal rate.  That is obvious so sorry for that one.  If inflation spikes (seems doubtful now but…) then you will have to increase your withdrawal rate or suffer a decline in living standards” I think this is a fact, maybe your definition of inflation spike differs from mine.  The Trinity authors even touch on this: “We found that all but 1 of the 18 failing portfolios spanned the high-inflation years of the late 1970s. As the withdrawals were adjusted upward as a result of high inflation and low financial market returns, the portfolios were depleted and failed. Thus, as in the analysis of 7 percent fixed withdrawals, extraordinary economic and financial circumstances explain the failures of the 5 percent inflation-adjusted withdrawals from 50 percent stock and 50 percent bond portfolios. As equivalent circumstances develop, clients have little choice but to reduce planned withdrawals in order to preserve their portfolios.” I also said “The capital losses on any long-term portfolio if rates go up will be hard to overcome.” That’s math but I guess I should have said “I think it will be hard to overcome”.  Finally I said what I did to arrive at my own withdrawal rate – that’s my own process that I used to come up with a withdrawal rate looking forward that I think is reasonable for me, not based on a study of the past.  Your point about the 7% interest rates at the time of the study is very valid.  I didn’t express myself clearly.  The 30 year periods that the revised Trinity study looks at began in 1926 and the last 30 year period began in 1981.  For most of that period the US was on the gold standard so I think inflation and interest rates were pretty tame.  In the 70’s when the gold standard was abandoned, inflation and interest rates spiked.  That is also the period where the Trinity study saw portfolios failing.  After the spike, I think in the early 80s bond yields fell from mid-teens to where we are today around 2-3%.  This drop in yields provided a huge boost to both bond returns and equity returns.  Something that I don’t think can happen going forward given our starting point today.  I think we are all trying to use their historical analysis to try to make a prediction about whether or not our nest egg can support our lifestyle in the future.  So I’m saying use their results with caution.  Again – I came up with my own way to figure out my own withdrawal rate based on what I think will happen going forward, and I shared it with the forum.
Mpbaker22: Thank you as well, I see that you are also a Senior Mustachian.  I am not saying that no one treats them as an expense.  That post I initiall put up was actually part of an email I sent my brother in response to a question he sent me on this topic. He hadn’t included taxes in his calculations.  I understand that you and many people on this forum are more knowledgeable of this process, but I have seen some spreadsheets that didn’t account for taxes.  I was just bringing it up in the hopes that others wouldn’t make that mistake.  My tax bracket is based on my actual taxes paid.  I’m in Canada, maybe that explains the discrepancy.  I’ve already talked about inflation above. Referring to this article by the Trinity authors http://www.fpanet.org/journal/CurrentIssue/TableofContents/PortfolioSuccessRates/  .  My comment about a $50k car was not meant to suggest that people should buy $50k cars or that they will ever buy a $50k car.  It was just an example of a large expenditure.  I could have said a $10k roof replacement or a $20k car.  The item wasn’t the point the point was the unexpected expenditure.  The large expenditures suggestion is probably stupid for someone like you who is very knowledgeable but again, it’s similar to my comment about taxes.  Just meant it as a word of caution, not meant to insult the intelligence of anyone on this forum.  My comment about a $50k car was not meant to suggest that people should buy $50k cars or that they will ever buy a $50k car.  It was just an example of a large expenditure.  I could have said a $10k roof replacement or a $20k car.  The item wasn’t the point the point was the unexpected expenditure.

alm0stk00l

  • 5 O'Clock Shadow
  • *
  • Posts: 92
  • Age: 36
  • Location: The awesome biking city of Houston
Re: Doubting the stock market
« Reply #23 on: January 28, 2014, 01:20:48 PM »
@daverobev
h
a
h
a
h
a
:)

mpbaker22

  • Handlebar Stache
  • *****
  • Posts: 1095
Re: Doubting the stock market
« Reply #24 on: January 28, 2014, 01:29:24 PM »
I apologize for my attitude.

That being said, it's extremely frustrating when the issue of SWRs is challenged in 10000 threads every week, with the same challenges and the same replies.  As my picture above indicated, the inflation issue in particular, has been beaten to death many many times.

Jamesqf

  • Magnum Stache
  • ******
  • Posts: 4047
Re: Doubting the stock market
« Reply #25 on: January 28, 2014, 01:46:04 PM »
Within 25 years of retiring, most people will be able to start to collect Social Security. Social Security (even at 60% of what the calculators say I should get) is enough for me to "succeed" at retirement...

One caution here: those calculators could be assuming that you are going to be working up to SS retirement age.  Since benefits are computed based on the 35 highest-earning years (indexed for inflation), putting in 10 or 20 ER years with zero earnings (subject to SS tax) could shrink the ultimate benefit quite a bit.

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 28029
  • Age: -999
  • Location: Seattle, WA
Re: Doubting the stock market
« Reply #26 on: January 28, 2014, 02:02:06 PM »
As my picture above indicated, the inflation issue in particular, has been beaten to death many many times.

Indeed.  And while I tried to make it clear that this is taken into account, it's still mentioned again in the wall of text above.

Quote
If inflation spikes (seems doubtful now but…) then you will have to increase your withdrawal rate or suffer a decline in living standards” I think this is a fact, maybe your definition of inflation spike differs from mine.

Yes, if inflation occurs, one will have to increase their spending.  However that has happened in the past (in fact the number one cause of failure in FIRECalc/cFIREsim is inflation, not market crashes) and thus is already taken into account in the worst case 4% SWR scenario (which does increase with inflation).  In other words, a person in the past who started with a 4% SWR and increased with inflation, and was hit with large inflation, was fine.

Yes, the 4% SWR increases with inflation.

I hear ya on getting frustrated at the repetition, mpbaker.  :)

People need to read and understand the study itself, not make assumptions about what a 4% SWR is.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

EscapeVelocity2020

  • Handlebar Stache
  • *****
  • Posts: 2344
  • Age: 45
  • Location: Houston
    • EscapeVelocity2020
Re: Doubting the stock market
« Reply #27 on: January 29, 2014, 08:03:01 AM »
Not sure if you guys have seen this recent paper "Asset Valuations and Safe Portfolio Withdrawal Rates", with Pfau as one of the authors:  http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2286146

One point of note, Pfau's trying to address a weakness to earlier SWR research (also inherent in FIRECalc): 

Assuming that future real returns on assets will equal the real returns experienced by investors in the past ignores current state information. This is particularly important if, as in the current period, there is a unique state where real bond yields are negative for durations of 10 years or less and stock valuations are much higher than the historical average. It is possible, however, to use state information from the past to estimate expected distributions of possible returns from market conditions that most closely resemble those that exist today in order to estimate the expected path of future returns. Rather than assuming the future will look like the average of all historic periods, we can instead assume that the future will resemble historic periods where asset valuations were most similar to those we see today.

Of course, no-one knows that this time it is different - but it's interesting reading.

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 28029
  • Age: -999
  • Location: Seattle, WA
Re: Doubting the stock market
« Reply #28 on: January 29, 2014, 08:45:48 AM »
Not sure if you guys have seen this recent paper "Asset Valuations and Safe Portfolio Withdrawal Rates", with Pfau as one of the authors:  http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2286146

One point of note, Pfau's trying to address a weakness to earlier SWR research (also inherent in FIRECalc): 

Assuming that future real returns on assets will equal the real returns experienced by investors in the past ignores current state information. This is particularly important if, as in the current period, there is a unique state where real bond yields are negative for durations of 10 years or less and stock valuations are much higher than the historical average. It is possible, however, to use state information from the past to estimate expected distributions of possible returns from market conditions that most closely resemble those that exist today in order to estimate the expected path of future returns. Rather than assuming the future will look like the average of all historic periods, we can instead assume that the future will resemble historic periods where asset valuations were most similar to those we see today.

Of course, no-one knows that this time it is different - but it's interesting reading.

(Emphasis mine.)

But that's not what the 4% Rule/FIRECalc/cFIREsim does.  It doesn't assume the future will look like the average; it assumes the future will be no worse than the worst time in that period.

In other words, the 4% rule isn't an average historical scenario, but the worst historical case.

And yes, I read Pfau regularly, and generally agree with him (including the article you mentioned).  But I needed to correct that misconception you stated, as too many people just plain don't understand the 4% rule and uncorrected statements like that perpetuate those misunderstandings.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

mpbaker22

  • Handlebar Stache
  • *****
  • Posts: 1095
Re: Doubting the stock market
« Reply #29 on: January 29, 2014, 09:06:45 AM »
Not sure if you guys have seen this recent paper "Asset Valuations and Safe Portfolio Withdrawal Rates", with Pfau as one of the authors:  http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2286146

One point of note, Pfau's trying to address a weakness to earlier SWR research (also inherent in FIRECalc): 

Assuming that future real returns on assets will equal the real returns experienced by investors in the past ignores current state information. This is particularly important if, as in the current period, there is a unique state where real bond yields are negative for durations of 10 years or less and stock valuations are much higher than the historical average. It is possible, however, to use state information from the past to estimate expected distributions of possible returns from market conditions that most closely resemble those that exist today in order to estimate the expected path of future returns. Rather than assuming the future will look like the average of all historic periods, we can instead assume that the future will resemble historic periods where asset valuations were most similar to those we see today.

Of course, no-one knows that this time it is different - but it's interesting reading.

(Emphasis mine.)

But that's not what the 4% Rule/FIRECalc/cFIREsim does.  It doesn't assume the future will look like the average; it assumes the future will be no worse than the worst time in that period.

In other words, the 4% rule isn't an average historical scenario, but the worst historical case.

And yes, I read Pfau regularly, and generally agree with him (including the article you mentioned).  But I needed to correct that misconception you stated, as too many people just plain don't understand the 4% rule and uncorrected statements like that perpetuate those misunderstandings.

Hmm.  My understanding, which I posted in another thread already today, is that the 4% rule is designed to only fail in 5% (or some such number)of cases.  You could then look at only points where the market was up 30% in the previous year, (or only points where the P/E was above value x, the indicator you choose doesn't matter).  Then you could do odds of failure given that the market is currently at point x, I.E. p(x|y)
However, now you only have 18 periods of length 1-year to look at, instead of 80.  One instance of failure only affects 80 1.25%, but it affects 18 by 5.5%.  I.E. the variance in this study is much higher, and the confidence intervals are also higher, because you're working with less data.

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 28029
  • Age: -999
  • Location: Seattle, WA
Re: Doubting the stock market
« Reply #30 on: January 29, 2014, 09:24:13 AM »
Correct.  4% has a 95% success rate.  Sites like FIRECalc or cFIREsim can help you narrow that further if you'd like a more precise (not necessarily accurate) number.

And yes, what you're describing is what Pfau did in the paper EV linked, and found that 4% was only safe about 48% of the time in those scenarios.  But there is the higher variance, as you point out.

Retiring after a market crash is naturally much safer than after a market peak.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

EscapeVelocity2020

  • Handlebar Stache
  • *****
  • Posts: 2344
  • Age: 45
  • Location: Houston
    • EscapeVelocity2020
Re: Doubting the stock market
« Reply #31 on: January 29, 2014, 09:39:09 AM »
Sorry Reb, I was quoting directly from the paper so maybe it looks out of context.  The quote is about what the paper is trying to do, not necessarily what FIRECalc does.  I understand your frustration about misunderstanding the Trinity Study and FIRECalc is very transparent about what it does on the FIRECalc homepage.  I put my original bold on the idea that Pfau proposes that we are in a unique period of low bond yield and high CAPE, that's what I meant to emphasize.

mpbaker22 - the paper also emphasizes that bond yields have only been this low once before at the end of WWII (then spiked up to 14% in the 1980's).  I think that it is this combination of high CAPE and low yield that is of interest to people debating the validity of 4%. CAPE was 16.9 for the starting period of 1940-49 (accompanied by an annualized 8.5% return) vs. 42.5 for the 2000-2009 period (with a -0.91% annualized return over that period).

I ended by saying that no-one knows that this time it will be different from any other period in history (in which case we are potentially following a line FIRECalc will not spit out), but we could just as well be re-living the retirement of our grandparents or our parents (which were also very different).  I like that Pfau is trying to make a more educated guess than what the original study intended (focusing in static portfolios and shortfall, with little attention to magnitude / timing of the shortfall).  This is of interest to us that are trying to figure out, in earnest, if I'm comfortable leaving a relatively good job right now since I think I have enough or if I wait and potentially expend valuable healthy years of my life only to hand over a big inheritance (which is not necessarily my goal). 

kyleaaa

  • Bristles
  • ***
  • Posts: 327
    • Kyle Bumpus
Re: Doubting the stock market
« Reply #32 on: January 29, 2014, 11:09:55 AM »
The 4% rule included many periods where stock valuations are higher than they are today. In short, 4% is the WORST CASE SCENARIO number. The actual safe withdrawal rate for most of modern stock market history has actually been much more than 4%. It all depends on where things stand the day you retire. Market returns the first year or two of your retirement will determine 90% of whether or not your portfolio will hold up over time. If, after a few years of bad returns, you are still young enough to go back to work for a few years, it really isn't going to be a problem for you. It's the 70 year olds who are screwed in that scenario. Mustachians will be fine.

That said, the 4% rule is explicitly only useful for 30 year retirements. That's part of the fine print. If you intend to be retired for more than 30 years, the 4% number is pretty meaningless. 3% is the generally accepted number for indefinite retirements.
« Last Edit: January 29, 2014, 11:16:50 AM by kyleaaa »

Poorman

  • Bristles
  • ***
  • Posts: 260
  • Age: 41
  • Location: Orange County, CA
Re: Doubting the stock market
« Reply #33 on: January 29, 2014, 11:24:09 AM »
The 4% rule included many periods where stock valuations are higher than they are today. In short, 4% is the WORST CASE SCENARIO number. The actual safe withdrawal rate for most of modern stock market history has actually been much more than 4%. It all depends on where things stand the day you retire. Market returns the first year or two of your retirement will determine 90% of whether or not your portfolio will hold up over time. If, after a few years of bad returns, you are still young enough to go back to work for a few years, it really isn't going to be a problem for you. It's the 70 year olds who are screwed in that scenario. Mustachians will be fine.

That said, the 4% rule is explicitly only useful for 30 year retirements. That's part of the fine print. If you intend to be retired for more than 30 years, the 4% number is pretty meaningless. 3% is the generally accepted number for indefinite retirements.

You might want to check that.  The CAPE measurement has only been higher 3 other times in the past 130 years.  Each time was before a significant crash.

mpbaker22

  • Handlebar Stache
  • *****
  • Posts: 1095
Re: Doubting the stock market
« Reply #34 on: January 29, 2014, 11:28:49 AM »
The 4% rule included many periods where stock valuations are higher than they are today. In short, 4% is the WORST CASE SCENARIO number. The actual safe withdrawal rate for most of modern stock market history has actually been much more than 4%. It all depends on where things stand the day you retire. Market returns the first year or two of your retirement will determine 90% of whether or not your portfolio will hold up over time. If, after a few years of bad returns, you are still young enough to go back to work for a few years, it really isn't going to be a problem for you. It's the 70 year olds who are screwed in that scenario. Mustachians will be fine.

That said, the 4% rule is explicitly only useful for 30 year retirements. That's part of the fine print. If you intend to be retired for more than 30 years, the 4% number is pretty meaningless. 3% is the generally accepted number for indefinite retirements.

No, a worst case scenario would be to actually put money into the account every year.  Your stocks could all go to $0 with a probability of 10^-x as x goes to infinity.  The 4% rules says you'll run out of money 5% of the time. 
If there are 1000 scenarios, that means 50 of them fail.  Additionally, a few percent of them come moderately close to failure.  If you wanted to do 60 years (30years twice), the probability of failure would be 5% + 5% times the withdrawal rate of those in the first scenario.  Obviously that's much more complicated, but just generically, I'd bet it'd be 6-7%. 
Or you could look at a 3% withdrawal rate.  Over 30 years, that might have .1% chance of failure.  But it might have 5% chance of resulting in lower than starting balance.  You could then look at those 50 outcomes and apply the 30 year rule to them at whatever that withdrawal rate is.  Then, you could calculate your new chance of failure.


In short, the 3% is just a piece-of-mind number.  The trinity study did look at various lengths of times and various withdrawal rates.  Based on the trinity study, a 3% withdrawal rate will maintain a positive balance ~100% of the time after 30 years.  Since someone retiring at 35 might need 60 years, they should look at that time frame.  The study didn't do 60 years, but I'm guessing success rate is still around 99%

goodlife

  • Stubble
  • **
  • Posts: 188
Re: Doubting the stock market
« Reply #35 on: January 29, 2014, 11:43:17 AM »

[/quote]

(Emphasis mine.)

But that's not what the 4% Rule/FIRECalc/cFIREsim does.  It doesn't assume the future will look like the average; it assumes the future will be no worse than the worst time in that period.

In other words, the 4% rule isn't an average historical scenario, but the worst historical case.

And yes, I read Pfau regularly, and generally agree with him (including the article you mentioned).  But I needed to correct that misconception you stated, as too many people just plain don't understand the 4% rule and uncorrected statements like that perpetuate those misunderstandings.
[/quote]

I applaud your optimism. I guess I am less optimistic and would certainly challenge that assumption. I hope this forum and all of us included will still be around in 30-50 years time and we can see how things panned out!

EscapeVelocity2020

  • Handlebar Stache
  • *****
  • Posts: 2344
  • Age: 45
  • Location: Houston
    • EscapeVelocity2020
Re: Doubting the stock market
« Reply #36 on: January 29, 2014, 12:36:39 PM »
Why do people keep missing the point of the paper, I guess no-one has had time to read it.  4% SWR was generated during a history which has not seen a whole lot of sub-3% bond environments, especially when compounded with high Market valuation.  Please don't get complacent that 4% SWR is a magic bullet guaranteeing 30 years of COLA'ed success 95% of the time going forward.  To highlight, the paper states:

Across the 132 different years with available data there are only 7 periods where the CAPE was above 20 and the yield on 10 year bonds was below 3.3% (1898, 1900, 1901, 1936, 2010, 2011, and 2012). Of these 7 periods only 4 occurred long enough ago so that we can test the sustainability of a retirement income strategy. We could, for example, use January 1937 as a proxy for what could happen, but this implicitly assumes a World War would commence roughly three years into the period. If we further restrict our bond yield to below 2.5% we only have two periods, 2011 and 2012, therefore we are definitely in relatively uncharted territory in terms of the potential implications of the impact for retirees.

Now, to cut to the conclusion, under current CAPE ~22 and bond yield of 2.0%, at an 80% equity allocation, a 4% SWR has a 55% probability of success, which is much lower than the original 95% the Trinity Study predicted.  Even more informative is Table 3 (copied): to get to an 80% success rate over a longer, 40 year retirement period SWR is predicted to be 2.1% (yikes!)

All I'm highlighting is, even Pfau is concerned that maybe the 4% rule is being misused in light of new research.
« Last Edit: January 29, 2014, 12:39:05 PM by EscapeVelocity2020 »

Poorman

  • Bristles
  • ***
  • Posts: 260
  • Age: 41
  • Location: Orange County, CA
Re: Doubting the stock market
« Reply #37 on: January 29, 2014, 01:17:28 PM »
Why do people keep missing the point of the paper, I guess no-one has had time to read it.  4% SWR was generated during a history which has not seen a whole lot of sub-3% bond environments, especially when compounded with high Market valuation.  Please don't get complacent that 4% SWR is a magic bullet guaranteeing 30 years of COLA'ed success 95% of the time going forward.  To highlight, the paper states:

Across the 132 different years with available data there are only 7 periods where the CAPE was above 20 and the yield on 10 year bonds was below 3.3% (1898, 1900, 1901, 1936, 2010, 2011, and 2012). Of these 7 periods only 4 occurred long enough ago so that we can test the sustainability of a retirement income strategy. We could, for example, use January 1937 as a proxy for what could happen, but this implicitly assumes a World War would commence roughly three years into the period. If we further restrict our bond yield to below 2.5% we only have two periods, 2011 and 2012, therefore we are definitely in relatively uncharted territory in terms of the potential implications of the impact for retirees.

Now, to cut to the conclusion, under current CAPE ~22 and bond yield of 2.0%, at an 80% equity allocation, a 4% SWR has a 55% probability of success, which is much lower than the original 95% the Trinity Study predicted.  Even more informative is Table 3 (copied): to get to an 80% success rate over a longer, 40 year retirement period SWR is predicted to be 2.1% (yikes!)

All I'm highlighting is, even Pfau is concerned that maybe the 4% rule is being misused in light of new research.

You should consider starting a new thread with this.  I don't think the importance of this research can be overstated.  Too many on this board are banking on 4% as a "sure" thing.

kyleaaa

  • Bristles
  • ***
  • Posts: 327
    • Kyle Bumpus
Re: Doubting the stock market
« Reply #38 on: January 29, 2014, 01:33:11 PM »
The 4% rule included many periods where stock valuations are higher than they are today. In short, 4% is the WORST CASE SCENARIO number. The actual safe withdrawal rate for most of modern stock market history has actually been much more than 4%. It all depends on where things stand the day you retire. Market returns the first year or two of your retirement will determine 90% of whether or not your portfolio will hold up over time. If, after a few years of bad returns, you are still young enough to go back to work for a few years, it really isn't going to be a problem for you. It's the 70 year olds who are screwed in that scenario. Mustachians will be fine.

That said, the 4% rule is explicitly only useful for 30 year retirements. That's part of the fine print. If you intend to be retired for more than 30 years, the 4% number is pretty meaningless. 3% is the generally accepted number for indefinite retirements.

No, a worst case scenario would be to actually put money into the account every year.  Your stocks could all go to $0 with a probability of 10^-x as x goes to infinity.  The 4% rules says you'll run out of money 5% of the time. 
If there are 1000 scenarios, that means 50 of them fail.  Additionally, a few percent of them come moderately close to failure.  If you wanted to do 60 years (30years twice), the probability of failure would be 5% + 5% times the withdrawal rate of those in the first scenario.  Obviously that's much more complicated, but just generically, I'd bet it'd be 6-7%. 
Or you could look at a 3% withdrawal rate.  Over 30 years, that might have .1% chance of failure.  But it might have 5% chance of resulting in lower than starting balance.  You could then look at those 50 outcomes and apply the 30 year rule to them at whatever that withdrawal rate is.  Then, you could calculate your new chance of failure.


In short, the 3% is just a piece-of-mind number.  The trinity study did look at various lengths of times and various withdrawal rates.  Based on the trinity study, a 3% withdrawal rate will maintain a positive balance ~100% of the time after 30 years.  Since someone retiring at 35 might need 60 years, they should look at that time frame.  The study didn't do 60 years, but I'm guessing success rate is still around 99%

You are missing the point. Everybody knows the Trinity study fixated on a 5% failure rate for the 4% number. That's common knowledge. I was correct in saying 4% represents the worst case scenario IN THE CONTEXT OF THE TRINITY STUDY. I swear, some people seem to take delight in intentionally taking things out of context. You are disagreeing with a statement I never made.

kyleaaa

  • Bristles
  • ***
  • Posts: 327
    • Kyle Bumpus
Re: Doubting the stock market
« Reply #39 on: January 29, 2014, 01:34:46 PM »
The 4% rule included many periods where stock valuations are higher than they are today. In short, 4% is the WORST CASE SCENARIO number. The actual safe withdrawal rate for most of modern stock market history has actually been much more than 4%. It all depends on where things stand the day you retire. Market returns the first year or two of your retirement will determine 90% of whether or not your portfolio will hold up over time. If, after a few years of bad returns, you are still young enough to go back to work for a few years, it really isn't going to be a problem for you. It's the 70 year olds who are screwed in that scenario. Mustachians will be fine.

That said, the 4% rule is explicitly only useful for 30 year retirements. That's part of the fine print. If you intend to be retired for more than 30 years, the 4% number is pretty meaningless. 3% is the generally accepted number for indefinite retirements.

You might want to check that.  The CAPE measurement has only been higher 3 other times in the past 130 years.  Each time was before a significant crash.

But regular old P/E ratios are well, well below historical highs and all the research shows PE10 isn't any better at predicting future returns than regular old PE. Conclusion: no reasonable conclusion is possible.

Poorman

  • Bristles
  • ***
  • Posts: 260
  • Age: 41
  • Location: Orange County, CA
Re: Doubting the stock market
« Reply #40 on: January 29, 2014, 01:54:55 PM »
The regular old P/E is also high by pre-1990 historical standards.  It's only when you include the insane valuations of the 1990's and early 2000,s that today's regular P/E looks sane.  The P/E or P/E10 aren't predictive, but they do show a measurement of value and buying at the times when P/E is near historical lows has always yielded the best results.  Today is not one of those times.

Eric

  • Magnum Stache
  • ******
  • Posts: 4061
  • Location: On my bike
Re: Doubting the stock market
« Reply #41 on: January 29, 2014, 02:10:56 PM »
Why do people keep missing the point of the paper, I guess no-one has had time to read it.  4% SWR was generated during a history which has not seen a whole lot of sub-3% bond environments, especially when compounded with high Market valuation.  Please don't get complacent that 4% SWR is a magic bullet guaranteeing 30 years of COLA'ed success 95% of the time going forward.  To highlight, the paper states:

Across the 132 different years with available data there are only 7 periods where the CAPE was above 20 and the yield on 10 year bonds was below 3.3% (1898, 1900, 1901, 1936, 2010, 2011, and 2012). Of these 7 periods only 4 occurred long enough ago so that we can test the sustainability of a retirement income strategy. We could, for example, use January 1937 as a proxy for what could happen, but this implicitly assumes a World War would commence roughly three years into the period. If we further restrict our bond yield to below 2.5% we only have two periods, 2011 and 2012, therefore we are definitely in relatively uncharted territory in terms of the potential implications of the impact for retirees.

Now, to cut to the conclusion, under current CAPE ~22 and bond yield of 2.0%, at an 80% equity allocation, a 4% SWR has a 55% probability of success, which is much lower than the original 95% the Trinity Study predicted.  Even more informative is Table 3 (copied): to get to an 80% success rate over a longer, 40 year retirement period SWR is predicted to be 2.1% (yikes!)

All I'm highlighting is, even Pfau is concerned that maybe the 4% rule is being misused in light of new research.

You should consider starting a new thread with this.  I don't think the importance of this research can be overstated.  Too many on this board are banking on 4% as a "sure" thing.

I'm not quite sure this is all that new or groundbreaking.  I can't speak for everyone, but I thought it was widely understood that if the market has a large drop right after you retire, then the chances are that you'll have to make some adjustments (lower w/d rate, earn income, lower spending, etc) in order to make your money last.  They even show in Figure 1 how important the timing is.  And that's the pretty much the point of the article.  Stating that CAPE is high is guessing that the market is likely to return lower than average returns (i.e. market drops likely) and since bond yields are low, they're unlikely to pick up the slack.  However, they also state that this is generally an unprecedented time period as these two things aren't normally happening concurrently.

Quote
Across the 132 different years with available data there are only 7 periods where the CAPE was above 20 and the yield on 10 year bonds was below 3.3% (1898, 1900, 1901, 1936, 2010, 2011, and 2012). Of these 7 periods only 4 occurred long enough ago so that we can test the sustainability of a retirement income strategy. We could, for example, use January 1937 as a proxy for what could happen, but this implicitly assumes a World War would commence roughly three years into the period. If we further restrict our bond yield to below 2.5% we only have two periods, 2011 and 2012, therefore we are definitely in relatively uncharted territory in terms of the potential implications of the impact for retirees.

So I'm not sure how you read this and decide that the 4% rule of thumb is lacking anymore than you would read it and decide that it is.

EscapeVelocity2020

  • Handlebar Stache
  • *****
  • Posts: 2344
  • Age: 45
  • Location: Houston
    • EscapeVelocity2020
Re: Doubting the stock market
« Reply #42 on: January 29, 2014, 02:26:49 PM »
You should consider starting a new thread with this.  I don't think the importance of this research can be overstated.  Too many on this board are banking on 4% as a "sure" thing.
Thanks for the encouragement Poorman.  I have linked to the research and maybe inadvertantly hijacked the thread, but I'm a little nervous to start a new thread judging by how touchy this 4% number is :)  I think I'll leave it where it is.  I have my own thoughts on my own blog (EscapeVelocity2020.com).

I'm not quite sure this is all that new or groundbreaking.  I can't speak for everyone, but I thought it was widely understood that if the market has a large drop right after you retire, then the chances are that you'll have to make some adjustments (lower w/d rate, earn income, lower spending, etc) in order to make your money last.  They even show in Figure 1 how important the timing is.  And that's the pretty much the point of the article.  Stating that CAPE is high is guessing that the market is likely to return lower than average returns (i.e. market drops likely) and since bond yields are low, they're unlikely to pick up the slack.  However, they also state that this is generally an unprecedented time period as these two things aren't normally happening concurrently.

So I'm not sure how you read this and decide that the 4% rule of thumb is lacking anymore than you would read it and decide that it is.
It's not groundbreaking per se, but it opened up my eyes that retiring on 4% today for 40 years is only about a 50-50 bet.  I read the paper and came to the conclusion that the 4% rule of thumb is lacking, but that was my reaction and not yours I suppose. 

Eric

  • Magnum Stache
  • ******
  • Posts: 4061
  • Location: On my bike
Re: Doubting the stock market
« Reply #43 on: January 29, 2014, 02:35:07 PM »
It's not groundbreaking per se, but it opened up my eyes that retiring on 4% today for 40 years is only about a 50-50 bet.  I read the paper and came to the conclusion that the 4% rule of thumb is lacking, but that was my reaction and not yours I suppose.

Here's where they kind of lost me though.  They state that we're in unprecedented times.  Then they still use historic bond returns to calculate future bond returns.  Same with stocks and CAPE.  However, aren't these linked?^  I'm no expert, but it's my speculation that stocks are high because bonds yields are so low and only likely to go lower when interest rates creep up.  Also remember that CAPE can decrease by either prices coming down or earnings going up.  Obviously only one of those is bad for the investor.

^I see the chart where they say that they haven't been linked in the past, but again, this period is not like (m)any in the past.

mpbaker22

  • Handlebar Stache
  • *****
  • Posts: 1095
Re: Doubting the stock market
« Reply #44 on: January 29, 2014, 02:56:36 PM »
The 4% rule included many periods where stock valuations are higher than they are today. In short, 4% is the WORST CASE SCENARIO number. The actual safe withdrawal rate for most of modern stock market history has actually been much more than 4%. It all depends on where things stand the day you retire. Market returns the first year or two of your retirement will determine 90% of whether or not your portfolio will hold up over time. If, after a few years of bad returns, you are still young enough to go back to work for a few years, it really isn't going to be a problem for you. It's the 70 year olds who are screwed in that scenario. Mustachians will be fine.

That said, the 4% rule is explicitly only useful for 30 year retirements. That's part of the fine print. If you intend to be retired for more than 30 years, the 4% number is pretty meaningless. 3% is the generally accepted number for indefinite retirements.

No, a worst case scenario would be to actually put money into the account every year.  Your stocks could all go to $0 with a probability of 10^-x as x goes to infinity.  The 4% rules says you'll run out of money 5% of the time. 
If there are 1000 scenarios, that means 50 of them fail.  Additionally, a few percent of them come moderately close to failure.  If you wanted to do 60 years (30years twice), the probability of failure would be 5% + 5% times the withdrawal rate of those in the first scenario.  Obviously that's much more complicated, but just generically, I'd bet it'd be 6-7%. 
Or you could look at a 3% withdrawal rate.  Over 30 years, that might have .1% chance of failure.  But it might have 5% chance of resulting in lower than starting balance.  You could then look at those 50 outcomes and apply the 30 year rule to them at whatever that withdrawal rate is.  Then, you could calculate your new chance of failure.


In short, the 3% is just a piece-of-mind number.  The trinity study did look at various lengths of times and various withdrawal rates.  Based on the trinity study, a 3% withdrawal rate will maintain a positive balance ~100% of the time after 30 years.  Since someone retiring at 35 might need 60 years, they should look at that time frame.  The study didn't do 60 years, but I'm guessing success rate is still around 99%

You are missing the point. Everybody knows the Trinity study fixated on a 5% failure rate for the 4% number. That's common knowledge. I was correct in saying 4% represents the worst case scenario IN THE CONTEXT OF THE TRINITY STUDY. I swear, some people seem to take delight in intentionally taking things out of context. You are disagreeing with a statement I never made.

What are you talking about?  Do you know what the phrase worst case scenario means?  Do you know what SWR means?

You're saying that you could withdraw more than 4% in a lot of cases.  Yes, that's true, except you don't know which case you're in until quite a few years down the road.  For that reason, 4% is somewhat risky, because you'll fail 5% of the time.  So, no, 4% is not a worst case number.  It's a 95th percentile case number.

EscapeVelocity2020

  • Handlebar Stache
  • *****
  • Posts: 2344
  • Age: 45
  • Location: Houston
    • EscapeVelocity2020
Re: Doubting the stock market
« Reply #45 on: January 29, 2014, 03:13:57 PM »
Here's where they kind of lost me though.  They state that we're in unprecedented times.  Then they still use historic bond returns to calculate future bond returns.  Same with stocks and CAPE.  However, aren't these linked?^  I'm no expert, but it's my speculation that stocks are high because bonds yields are so low and only likely to go lower when interest rates creep up.  Also remember that CAPE can decrease by either prices coming down or earnings going up.  Obviously only one of those is bad for the investor.

^I see the chart where they say that they haven't been linked in the past, but again, this period is not like (m)any in the past.
I agree that de-linking is a debatable area of the paper, but the authors have pointed out that 2011 and 2012 are the closest analogies with representative historical data similar to today's environment, which doesn't give much retirement confidence interval!  They describe the de-linking and forecasting models, as to how they have gone about using the historic bond yield and stock return models to follow each historically, but individually.  I can't think of a better way they could have done it. 
Although low bond rates should generally correlate with high P/E (rational investors are supposed to expect a 'yield' from purchasing an index, or E/P, to be similar to what they would get risk free from a 30-year government bond), but this correlation is sometimes positive and sometimes negative.  There is too much noise around earnings growth and Fed policy to give anyone a clear picture of how these interact concurrently.  But we are currently at a point where the market is paying roughly twice as much for a company's earnings than what they would get risk free from Uncle Sam.  It seems most likely that bond rates will move up, and P/E stay the same or move down, but P/E is certainly the faster moving of the two, which adds a whole other layer of complexity of risk.

chucklesmcgee

  • Pencil Stache
  • ****
  • Posts: 613
Re: Doubting the stock market
« Reply #46 on: January 29, 2014, 03:37:41 PM »
Yes, that's true, except you don't know which case you're in until quite a few years down the road.  For that reason, 4% is somewhat risky, because you'll fail 5% of the time.  So, no, 4% is not a worst case number.  It's a 95th percentile case number.

That's all assuming stock market returns fall somewhere within historical norms, which is exactly the assumption OP is criticizing. There is no sort of absolute rule or formal logic which says stock market returns must match anything close to what they have during the last ~100 something years. This time period has seen the US rise to the dominant global super power with extraordinary growth in population, standard of living, efficiency and economic output. There's no guarantee that the next 100 years will continue to see that unprecedented growth or prosperity. Stock market returns are not generated by randomly pulling a number out of a normal distribution, but we treat it like it's so when we perform these simulations. The market could well generate returns well below or above historic returns and these models offer no probability of this occurring.

Nevertheless, these simulations probably provide the best guess as to how a portfolio will perform, but keep in mind it's only a guess, and percentiles are all based on this assumption.

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 28029
  • Age: -999
  • Location: Seattle, WA
Re: Doubting the stock market
« Reply #47 on: January 29, 2014, 03:58:00 PM »
EscapeVelocity, I appreciate your posts.  Thank you.

To me, anyone rigidly withdrawing a certain number, whether it's 2% or 4%, is acting foolishly.  A withdrawal plan ought to be flexible.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

Shor

  • Bristles
  • ***
  • Posts: 480
  • Location: Orange County, CA, USA
Re: Doubting the stock market
« Reply #48 on: January 29, 2014, 04:35:11 PM »
Not only should your withdrawal plan be flexible to account for unexpected market conditions, but an early retiree would be well-advised to keep their entire retirement flexible.

Whether that means pursuing a side-gig, or re-entering the workforce. It's not ideal, sure, but you are retiring early early, and a lot can happen over the next 50 years, including outlasting your well-planned retirement fund.

I think some people are still a bit stuck on retirement being focused entirely on productivity dropping to 0. The much more likely route of success is that productivity goes towards that one hobby or interest you really want to pursue, turn it in to a side gig and now your withdrawal is supplemented by your side-gig income. Yes you had retired planning to draw down 4% but now you have 2% coming from the main-sidegig and a nice fat 2% withdraw for a year or two (or forever). Suddenly your chances are looking a bit better with more money in the stash and less coming out of it.

Or maybe we're all just going to retire as internet warrior hermit monks..

thepokercab

  • Bristles
  • ***
  • Posts: 486
Re: Doubting the stock market
« Reply #49 on: January 29, 2014, 04:56:36 PM »
Quote
I think some people are still a bit stuck on retirement being focused entirely on productivity dropping to 0. The much more likely route of success is that productivity goes towards that one hobby or interest you really want to pursue, turn it in to a side gig and now your withdrawal is supplemented by your side-gig income. Yes you had retired planning to draw down 4% but now you have 2% coming from the main-sidegig and a nice fat 2% withdraw for a year or two (or forever). Suddenly your chances are looking a bit better with more money in the stash and less coming out of it.

Or maybe we're all just going to retire as internet warrior hermit monks..

This for sure.  The 4% rule is a nice baseline, but the corollary to this is needing to have a safety margin.  Working a few more years full time, having side gigs, being able to adapt your lifestyle to economic conditions, maybe having a rental property, whatever it may be.  I've found this discussion interesting from an academic perspective, but in practice, i doubt many people are looking to to hit exactly 25 times their living expenses in investments, drop off the grid spending all their time playing X-Box and then hope that their money lasts them forever all while never adjusting their living expenses, or adding one additional dollar to the situation.