Author Topic: Never reallocating away from 100% equity with age?  (Read 16604 times)

PencilMustache

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Never reallocating away from 100% equity with age?
« on: June 11, 2014, 11:59:47 AM »
Hello Mustachians!

I don't know if this idea has been brought up before, but I had the thought today of "What if you didn't reallocate away from 100% equity as you age?" It seems like lots of financial resources tell you that you need more bonds as you get older, for stability, but I wanted to test that idea out using a FIRE sim. The FIRE sim I used for these tests is cFIREsim. Here are the initial conditions (as they differ from the default configuration), which are as close to my family's condition as I could get:

Portfolio: 50000
Spending: 20000
Retirement Year: 2020
Years to Model: 60
Inflation adjusted spending
Keep Allocation Constant
Equities: 100%
Fees: 0.05% (VTSAX)
Other Income/Saving 1: Amount: 100000 Start Year: 2014 End Year: 2020 (This is income until we retire)
Other Spending 1: Amount: 50000 Start Year: 2028 One Time (This is a downpayment on a house)
Other Spending 2: Amount: 17000 Start Year: 2028 End Year: 2043 (This is the 15 year mortgage on the house)
No Investigation

I know this model doesn't take into account a lot of things, but it seems accurate enough for me. Running this simulation gives you the results of never changing the allocation from 100% equity. Under the "Portfolio Inputs" section, you can choose "Gradual Allocation Change" and set it to "Change Allocation Gradually". For two alternate simulations, I chose to change the allocation to 75/25 stock/bond in between the years 2025-2035 and 2055-2065 to simulate shifting allocation when I retire and around when I'm 60, respectively.

All three of the above simulations give 100% success rate, but their ending balances show that keeping 100% equity leaves you the richest person in the graveyard. Now, since being the richest dead person isn't actually a good goal, and since we might get different results this way, I chose to run a second set of simulations. I kept all the same initial parameters, except I increased my spending rate until I got less than 100% success rate. My thinking in doing this was "Maybe stabilizing your investments with bonds actually helps you out when you aren't guaranteed to not run out of money."

You can follow along by increasing the spending of this model to $30000. This gives you 83% success rate for each of the three simulations. However, the median ending portfolio amounts are higher the later you reallocate, and highest for no reallocation at all. Increasing spending by even more gives you an actual change in the success rates, with the early reallocation having the least success and the later reallocation and no reallocation giving the same. Messing with even more variables to give a wider spread shows that the success rate is lowest for early reallocation, highest for no reallocation, and in the middle for late reallocation.

So what does this mean for the advice that you should change allocation as you age? I might be missing something huge that repudiates all of my findings, but if I'm not, it begs a serious reconsideration of this age-old rule of thumb.

Please let me know your thoughts on this and anywhere I might have made mistakes.
« Last Edit: June 12, 2014, 03:00:50 PM by PencilMustache »

gimp

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Re: Never reallocating from 100% equity with age?
« Reply #1 on: June 11, 2014, 12:27:13 PM »
I don't plan on it either. I might go for REITs, but I don't think I'll ever need bonds to smooth out the drops - I'll just survive them.

forward

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Re: Never reallocating from 100% equity with age?
« Reply #2 on: June 11, 2014, 01:22:54 PM »

I believe the model as you have set it up works.  The typical increasing bond or fixed percentage is in my view meant to stabilize and provide a more predictable year to year amount to withdraw.  It is also a function of the endowment effect, people don't want to lose what they have built.

I have thought about a version of this in that, why should I reduce my equity holdings from 100% until after the day I reach FI/ER?  Meaning it doesn't really matter how much I have until I reach that goal.  I still have to work until that day.  Just a thought.

AssetGrinder

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Re: Never reallocating from 100% equity with age?
« Reply #3 on: June 11, 2014, 01:49:45 PM »
Technically it would work but in real life things happen. What if you were to retire at 65 and the next day the market plunged 50%. That fixed return on bonds will power you through the recovery of your portfolio!. Fixed income should have a place in everybodies portfolio. Doesn't have to be a large pcnt but definitely an area for it.

brooklynguy

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Re: Never reallocating from 100% equity with age?
« Reply #4 on: June 11, 2014, 02:03:50 PM »
Technically it would work but in real life things happen. What if you were to retire at 65 and the next day the market plunged 50%. That fixed return on bonds will power you through the recovery of your portfolio!. Fixed income should have a place in everybodies portfolio. Doesn't have to be a large pcnt but definitely an area for it.

But the cfiresim simulations account for all the historical periods where a precipitous market drop occurred immediately after retirement and they still tell you that having a 100% equity allocation both decreased the risk of portfolio failure AND resulted in a larger portfolio at death.

PencilMustache

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Re: Never reallocating from 100% equity with age?
« Reply #5 on: June 11, 2014, 02:08:07 PM »
But the cfiresim simulations account for all the historical periods where a precipitous market drop occurred immediately after retirement and they still tell you that having a 100% equity allocation both decreased the risk of portfolio failure AND resulted in a larger portfolio at death.

This is exactly why I model all of my investment decisions on a FIRE sim! What happens if a great depression happens right after I retire? This little line right here shows what would have happened when THE great depression happened at that time in my retirement. The Trinity Study, and it's offspring FIRE calcs (cFIREsim and FIREcalc are the ones I use) are a godsend for early retirement planners.

Cheddar Stacker

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Re: Never reallocating from 100% equity with age?
« Reply #6 on: June 11, 2014, 02:12:06 PM »
This is a pretty good, relatively recent thread that discussed bond allocation and asset allocation in retirement. It's probably a good read if you haven't already. The whole thing is good, but reply #26 makes a very good point about the article, then there's a lot of back and forth about the cfiresim success rates for a 100% stock portfolio vs. any bond allocation.

http://forum.mrmoneymustache.com/investor-alley/william-bernstein-the-worst-retirement-investing-mistake/msg273112/#msg273112

I would argue going 100% stocks is more risky in the short-term, safer in the long-term, and could allow for an earlier retirement.

PencilMustache

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Re: Never reallocating from 100% equity with age?
« Reply #7 on: June 11, 2014, 02:29:16 PM »
This is a pretty good, relatively recent thread that discussed bond allocation and asset allocation in retirement. It's probably a good read if you haven't already. The whole thing is good, but reply #26 makes a very good point about the article, then there's a lot of back and forth about the cfiresim success rates for a 100% stock portfolio vs. any bond allocation.

http://forum.mrmoneymustache.com/investor-alley/william-bernstein-the-worst-retirement-investing-mistake/msg273112/#msg273112

I would argue going 100% stocks is more risky in the short-term, safer in the long-term, and could allow for an earlier retirement.

Thank you for the link to that article. There are definitely some really good points there. When they talked about how "When you reach a certain level of money, safer options open up to you", this is exactly what my simulation with changing allocation in between 2055-2065 shows. It doesn't increase or decrease your success rate (because by then your savings are already so high, it would take a long time for the decreased earning power to affect you), just affects how much money you have when you die, which is ultimately meaningless (outside of estate).

I also really agree with the idea that there needs to be a distinction between different versions of the word "safe". When people say it, do they mean volatility, or success rate? When I tell my family about index funds, I say that VTSAX is very volatile, but it is safe in that you aren't going to lose all of your money in it. And even if you do, at that point you've got more serious problems (like roving armed gangs in your post-apocalyptic neighborhood) and are going to wish you had invested in gold and bullets.
« Last Edit: June 11, 2014, 02:34:37 PM by PencilMustache »

brooklynguy

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Re: Never reallocating from 100% equity with age?
« Reply #8 on: June 11, 2014, 02:56:15 PM »
Cheddar Stacker, thanks for the reminder about that thread!  When I initially read (and participated) in it, it challenged the way I thought about my long term investment strategy.  Right now I'm still in the accumulation phase so I'm 100% equity anyway, but I made a mental note to remember about the discussion in that thread for the future.  Yet here it is two months later and I had already forgotten!

Cheddar Stacker

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Re: Never reallocating from 100% equity with age?
« Reply #9 on: June 11, 2014, 03:07:55 PM »
You're welcome. The other guys in that thread did all the heavy lifting. I'm still learning a lot here, but it's nice to be able to reference some of this "old" stuff sometimes.

wtjbatman

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Re: Never reallocating from 100% equity with age?
« Reply #10 on: June 11, 2014, 05:50:23 PM »
Warren Buffet recently recommended the average investor have a 90/10 AA. 90% equities, 10% short term govt bonds. Personally I'm 100% equities (including REITs) due to my investment strategy of dividend growth investing, but I understand that most people who are index investors are told things like "Bonds in age". As you observed with the simulators, that might not be necessary. I think it depends more on the individual person. As long as you have a sound strategy that allows you to sleep at night, and you stick with it, you will be fine.

PencilMustache

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Re: Never reallocating from 100% equity with age?
« Reply #11 on: June 11, 2014, 06:11:48 PM »
Warren Buffet recently recommended the average investor have a 90/10 AA. 90% equities, 10% short term govt bonds. Personally I'm 100% equities (including REITs) due to my investment strategy of dividend growth investing, but I understand that most people who are index investors are told things like "Bonds in age". As you observed with the simulators, that might not be necessary. I think it depends more on the individual person. As long as you have a sound strategy that allows you to sleep at night, and you stick with it, you will be fine.

You are absolutely right! At this point we are nit picking, the main thing you need for success is to pick some strategy and stick with it through the years.

arebelspy

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Re: Never reallocating from 100% equity with age?
« Reply #12 on: June 11, 2014, 08:14:19 PM »
I agree with staying aggressive.  I still like some small amount (cash, bonds, whatever) to be non-equities for rebalancing purposes.

90/10 or 80/20 sounds good to me for someone with a long life expectancy left.  If you're down to < 30 years, I'm okay with you nudging below that (and/or if you're very risk adverse such that you want to work extra years and build a larger stache to have less volatility).

Jim Collins just had a post quite relevant to this discussion:
http://jlcollinsnh.com/2014/06/10/stocks-part-xxiii-selecting-your-asset-allocation/
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Dodge

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Re: Never reallocating from 100% equity with age?
« Reply #13 on: June 11, 2014, 08:57:48 PM »
I use Vanguard's retirement nest egg calculator:

https://retirementplans.vanguard.com/VGApp/pe/pubeducation/calculators/RetirementNestEggCalc.jsf?cbdForceDomain=false

With 100 stocks / 0 bonds, a 4% withdraw rate, and a 50 year time horizon, here are the chances of success I get:

80%
79%
80%

When I change to 90 stocks / 10 bonds

81%
81%
82%

80 stocks / 20 bonds

82%
82%
81%

70 stocks / 30 bonds

82%
82%
84%

60 stocks / 40 bonds

81%
82%
80%

This data supports the idea that when you're in retirement, and withdrawing from the nest egg, some bonds provide a higher success rate, when compared to 100% stocks.

PencilMustache

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Re: Never reallocating from 100% equity with age?
« Reply #14 on: June 12, 2014, 07:59:18 AM »
I agree with staying aggressive.  I still like some small amount (cash, bonds, whatever) to be non-equities for rebalancing purposes.

90/10 or 80/20 sounds good to me for someone with a long life expectancy left.  If you're down to < 30 years, I'm okay with you nudging below that (and/or if you're very risk adverse such that you want to work extra years and build a larger stache to have less volatility).

Jim Collins just had a post quite relevant to this discussion:
http://jlcollinsnh.com/2014/06/10/stocks-part-xxiii-selecting-your-asset-allocation/

Hey arebelspy, thanks for dropping in! I agree, I think staying aggressive is the way to go. I was wondering about your adherence to 90/10 or 80/20 with the results I got in my opening post. Is it due to your personal risk threshold, or perhaps due to how new and untested (except computationally) the idea of 100% equities is? I ask because I think that hearing your views will help us understand the weaknesses in my simulations above.

PencilMustache

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Re: Never reallocating from 100% equity with age?
« Reply #15 on: June 12, 2014, 08:01:25 AM »
I use Vanguard's retirement nest egg calculator:
This data supports the idea that when you're in retirement, and withdrawing from the nest egg, some bonds provide a higher success rate, when compared to 100% stocks.

I wonder what data they are using and assumptions they are making for the percentages they return, since their success rates seem wildly different than what you would get using a FIRE sim.

brooklynguy

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Re: Never reallocating from 100% equity with age?
« Reply #16 on: June 12, 2014, 08:35:57 AM »
I agree with staying aggressive.  I still like some small amount (cash, bonds, whatever) to be non-equities for rebalancing purposes.

90/10 or 80/20 sounds good to me for someone with a long life expectancy left.  If you're down to < 30 years, I'm okay with you nudging below that (and/or if you're very risk adverse such that you want to work extra years and build a larger stache to have less volatility).

This was my gut reaction at first too, and the reason I resisted skyrefuge's argument in the William Bernstein thread that the ONLY reason to hold bonds is to have an emotional security blanket.  But I think I'm coming around to the view that if you have the emotional discipline to follow cold Vulcan logic, it's better to hold 100% equities.  The notion that it makes sense to have a small percentage of non-stock assets to use as "dry powder" in downturns just isn't supported by the historical data.  Throughout the historical periods covered by cfiresim, it seems the only way a long term investor/early retiree could have been better off by holding anything less than 100% equities is by accurately timing the market.

So I'm starting to think the only time it makes sense to add bonds to the mix is once your portfolio has grown large enough to support dialing back risk because anything more is just extra beyond "enough" (but personally I'm still in the "might as well continue to let it ride" camp).

PencilMustache

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Re: Never reallocating from 100% equity with age?
« Reply #17 on: June 12, 2014, 12:59:34 PM »
This was my gut reaction at first too, and the reason I resisted skyrefuge's argument in the William Bernstein thread that the ONLY reason to hold bonds is to have an emotional security blanket.  But I think I'm coming around to the view that if you have the emotional discipline to follow cold Vulcan logic, it's better to hold 100% equities.  The notion that it makes sense to have a small percentage of non-stock assets to use as "dry powder" in downturns just isn't supported by the historical data.  Throughout the historical periods covered by cfiresim, it seems the only way a long term investor/early retiree could have been better off by holding anything less than 100% equities is by accurately timing the market.

So I'm starting to think the only time it makes sense to add bonds to the mix is once your portfolio has grown large enough to support dialing back risk because anything more is just extra beyond "enough" (but personally I'm still in the "might as well continue to let it ride" camp).

You've hit on a great point here, which is the "vulcan logic" requirement of this plan. Keeping 100% equities is, more so than most other plans, really really scary. The most dangerous thing you can do to any plan is to abandon it, and that risk is the highest when using a plan like this. So in this way, this plan is actually very risky, but only if you take into account the risk of the participant freaking out. The way I plan to combat this is to go into the plan with a solid theoretical foundation (like the analysis I did on the OP) and then just never look at my investment amounts (unless I'm doing something like adding to it, which is when you have to look). I feel like a combination of knowing that crashes will happen and not keeping an eye on your investments will help an investor to keep their cool when the heat gets hot. With a plan like this, the heat will get very hot!

kyleaaa

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Re: Never reallocating from 100% equity with age?
« Reply #18 on: June 12, 2014, 01:24:00 PM »
All the SWR studies I'm aware of assume between 20-80% equities, so you're somewhat in uncharted territory.

PencilMustache

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Re: Never reallocating from 100% equity with age?
« Reply #19 on: June 12, 2014, 01:44:10 PM »
All the SWR studies I'm aware of assume between 20-80% equities, so you're somewhat in uncharted territory.

You are right, it's weird that this hasn't been done before. Maybe the idea of needing some percentage of bonds for stability is just so ingrained that no one thought to do any simulations with 100% equities? I wish I had a program that would do firecalcs so I could try to find any situations where 100% equities did worse than increasing bond allocation over time.

warfreak2

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Re: Never reallocating away from 100% equity with age?
« Reply #20 on: June 12, 2014, 03:13:50 PM »
The original Trinity study looked at 100%/0%, 75%/25%, 50%/50%, 25%/75% and 0%/100%. 100%/0% did a little worse than 75%/25%, over 30 year withdrawal periods at least.

PencilMustache

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Re: Never reallocating away from 100% equity with age?
« Reply #21 on: June 12, 2014, 03:26:22 PM »
The original Trinity study looked at 100%/0%, 75%/25%, 50%/50%, 25%/75% and 0%/100%. 100%/0% did a little worse than 75%/25%, over 30 year withdrawal periods at least.

I had read that as well. For some reason, I can't replicate those results with cFIREsim when selecting to investigate asset allocation. I used the default settings with a 60 year period, and chose "Investigate Asset Allocation". Have you had any luck getting results that support the original study with cFIREsim?

Tyler

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Re: Never reallocating away from 100% equity with age?
« Reply #22 on: June 12, 2014, 03:46:55 PM »
So what does this mean for the advice that you should change allocation as you age?  I might be missing something huge that repudiates all of my findings, but if I'm not, it begs a serious reconsideration of this age-old rule of thumb.

IMHO, people too often rely on FIRE simulators to tell them what scenario would have survived without considering the psychological aspect of what they would have been able to stick with long enough to allow the portfolio to recover from major negative events.

For example, using the provided data gives a 100% success rate if one sticks to the plan of holding 100% stocks with no changes.  However, 88% of the runs had a dip of greater than 40%, and 44% of the runs had a dip of greater than 60%!  Would you be willing to watch your portfolio plummet by two-thirds and stick to your guns with 100% stock?  If so, maybe that's a good option for you.  If not, asset diversification can help you sleep much better while still generating more than enough money.
« Last Edit: June 12, 2014, 03:48:29 PM by Tyler »

warfreak2

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Re: Never reallocating away from 100% equity with age?
« Reply #23 on: June 12, 2014, 03:53:44 PM »
For some reason, I can't replicate those results with cFIREsim
There's a few reasons for that. Mainly, the Trinity Study used the S&P 500 and "long-term high grade domestic bonds", while I wasn't able to discern what indices cFIREsim uses for "equities" and "bonds", but at least one is probably different to the indices used in the original Trinity study.

Otherwise, the Trinity study included fees in the withdrawal while cFIREsim has a seperate setting for this (you will have to set it to 0 to reproduce the Trinity study's conditions), and the Trinity study only looked from 1925 to 1995 while cFIREsim has both more recent and more historical data (you will have to tell it to only use data from a particular time range).

wtjbatman

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Re: Never reallocating away from 100% equity with age?
« Reply #24 on: June 12, 2014, 04:04:26 PM »
The original Trinity study looked at 100%/0%, 75%/25%, 50%/50%, 25%/75% and 0%/100%. 100%/0% did a little worse than 75%/25%, over 30 year withdrawal periods at least.

The original Trinity study done in 1996 also shows that a 25%/75% allocation while withdrawing 6% (!) over 30 years has a 100% success rate.

Wade Pfau's updated figures from 2009, showing the exact same allocation and withdrawal rate over 30 years? A 22% success rate. Yikes. According to Pfau, there is no AA that will give you a 100% success rate over 30 years if you're withdrawing 4%.

hodedofome

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Re: Never reallocating away from 100% equity with age?
« Reply #25 on: June 12, 2014, 04:06:35 PM »
So what does this mean for the advice that you should change allocation as you age?  I might be missing something huge that repudiates all of my findings, but if I'm not, it begs a serious reconsideration of this age-old rule of thumb.

IMHO, people too often rely on FIRE simulators to tell them what scenario would have survived without considering the psychological aspect of what they would have been able to stick with long enough to allow the portfolio to recover from major negative events.

For example, using the provided data gives a 100% success rate if one sticks to the plan of holding 100% stocks with no changes.  However, 88% of the runs had a dip of greater than 40%, and 44% of the runs had a dip of greater than 60%!  Would you be willing to watch your portfolio plummet by two-thirds and stick to your guns with 100% stock?  If so, maybe that's a good option for you.  If not, asset diversification can help you sleep much better while still generating more than enough money.

Agreed. Strategies are easy. It's sticking with them when they suck, is the hard part.

warfreak2

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Re: Never reallocating away from 100% equity with age?
« Reply #26 on: June 12, 2014, 04:09:09 PM »
According to Pfau, there is no AA that will give you a 100% success rate over 30 years if you're withdrawing 4%.
Is this just looking at stocks and bonds, or does it include other things like REITs, gold, timber, pork bellies, frozen orange juice, &c.? Also, does it consider leveraged allocations?
« Last Edit: June 12, 2014, 04:21:27 PM by warfreak2 »

PencilMustache

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Re: Never reallocating away from 100% equity with age?
« Reply #27 on: June 12, 2014, 04:12:49 PM »
IMHO, people too often rely on FIRE simulators to tell them what scenario would have survived without considering the psychological aspect of what they would have been able to stick with long enough to allow the portfolio to recover from major negative events.

For example, using the provided data gives a 100% success rate if one sticks to the plan of holding 100% stocks with no changes.  However, 88% of the runs had a dip of greater than 40%, and 44% of the runs had a dip of greater than 60%!  Would you be willing to watch your portfolio plummet by two-thirds and stick to your guns with 100% stock?  If so, maybe that's a good option for you.  If not, asset diversification can help you sleep much better while still generating more than enough money.

You are absolutely right here: while this is theoretically the "safest" (in the sense of it succeeding, not in the sense of variability) asset allocation, it is at the same time the most unsafe asset allocation due to it's high ability to make it's users deviate from the plan (and as we all know, that is the true killer more than anything else). I would definitely not recommend this to anyone I know, unless they were capable of running through the near-wipeouts with stoic determinism based on their theoretical knowledge. The MMM recommended book "The Intelligent Asset Allocator" is a great theoretical piece on the stabilizing effects of allocation.

There's a few reasons for that. Mainly, the Trinity Study used the S&P 500 and "long-term high grade domestic bonds", while I wasn't able to discern what indices cFIREsim uses for "equities" and "bonds", but at least one is probably different to the indices used in the original Trinity study.

Otherwise, the Trinity study included fees in the withdrawal while cFIREsim has a seperate setting for this (you will have to set it to 0 to reproduce the Trinity study's conditions), and the Trinity study only looked from 1925 to 1995 while cFIREsim has both more recent and more historical data (you will have to tell it to only use data from a particular time range).

I didn't know these differences in methodology in the Trinity study, thanks!

The original Trinity study done in 1996 also shows that a 25%/75% allocation while withdrawing 6% (!) over 30 years has a 100% success rate.

Wade Pfau's updated figures from 2009, showing the exact same allocation and withdrawal rate over 30 years? A 22% success rate. Yikes. According to Pfau, there is no AA that will give you a 100% success rate over 30 years if you're withdrawing 4%.

Do you mean "if you're withdrawing 6%" in your last sentence? What were the differences between the two studies? Was it due to the incorporation of the 2008 crash figures?

Agreed. Strategies are easy. It's sticking with them when they suck, is the hard part.

That's why I'm planning to just set it and forget it.

wtjbatman

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Re: Never reallocating away from 100% equity with age?
« Reply #28 on: June 12, 2014, 04:38:02 PM »
The original Trinity study done in 1996 also shows that a 25%/75% allocation while withdrawing 6% (!) over 30 years has a 100% success rate.

Wade Pfau's updated figures from 2009, showing the exact same allocation and withdrawal rate over 30 years? A 22% success rate. Yikes. According to Pfau, there is no AA that will give you a 100% success rate over 30 years if you're withdrawing 4%.

Do you mean "if you're withdrawing 6%" in your last sentence? What were the differences between the two studies? Was it due to the incorporation of the 2008 crash figures?

Nope, I meant 4%. According to his figures there is no way to achieve a safe withdrawal rate of 4% (safe being defined as 100% success anyway) using the trinity study portfolio (your stock allocation is in large caps, your bond allocation is in corporate bonds).

I would assume the main difference is the additional 13 or so years of financial data, during which we had two big crashes.

PencilMustache

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Re: Never reallocating away from 100% equity with age?
« Reply #29 on: June 12, 2014, 05:04:29 PM »
Nope, I meant 4%. According to his figures there is no way to achieve a safe withdrawal rate of 4% (safe being defined as 100% success anyway) using the trinity study portfolio (your stock allocation is in large caps, your bond allocation is in corporate bonds).

I would assume the main difference is the additional 13 or so years of financial data, during which we had two big crashes.

If this is the study you were talking about, it does paint a very interesting future for investing. Correct me if I am wrong, but in this paper were they looking at updated bond interest rates specifically? If it was these new bond rates that affected SWR so drastically, would upping your percentage of equity (or just completely getting out of bonds altogether) offset the majority of this paradigm shift?

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Re: Never reallocating away from 100% equity with age?
« Reply #30 on: June 12, 2014, 06:06:24 PM »
I would like to see fire sim give me equity options over 100%. 

Also, what happens if the next Great Depression is 10% deeper? 

It would be nice for the developer to also include future returns in the simulations

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Re: Never reallocating away from 100% equity with age?
« Reply #31 on: June 12, 2014, 07:10:14 PM »
It would be nice for the developer to also include future returns in the simulations

THAT'S the killer feature they've been missing.

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Re: Never reallocating away from 100% equity with age?
« Reply #32 on: June 13, 2014, 01:41:41 AM »
I think the main issue with FIRE simulators is the use of historical input. Historical data cannot represent rare events correctly. If there are lots of possible rare events (with low possibilities so that they happen on average every 200 years in a modern world), many of these possible rare events will not have happened in our timeline yet. You do not find a trace of them in historical data but you should expect to see some of these events happen during your lifetime for the first time ever.

Diversification protects you not only against known risks, but also against unknown risks - if you experience a Black Swan event which permanently wipes out a large part of your equity portfolio, other assets can help soften the blow.

I also disagree that an equity wipeout is only thinkable in apocalyptic settings. Stocks are leveraged investments, because most companies finance between 50% and 70% of their assets with debt. If an economic or financial crisis makes all company assets lose just 30% of their value (which would set us back a few decades but not to the stone age), then the losses would be almost completely absorbed by equity, with stocks losing most of their value.

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Re: Never reallocating away from 100% equity with age?
« Reply #33 on: June 13, 2014, 08:42:02 AM »
I think the main issue with FIRE simulators is the use of historical input. Historical data cannot represent rare events correctly. If there are lots of possible rare events (with low possibilities so that they happen on average every 200 years in a modern world), many of these possible rare events will not have happened in our timeline yet. You do not find a trace of them in historical data but you should expect to see some of these events happen during your lifetime for the first time ever.

Diversification protects you not only against known risks, but also against unknown risks - if you experience a Black Swan event which permanently wipes out a large part of your equity portfolio, other assets can help soften the blow.

I also disagree that an equity wipeout is only thinkable in apocalyptic settings. Stocks are leveraged investments, because most companies finance between 50% and 70% of their assets with debt. If an economic or financial crisis makes all company assets lose just 30% of their value (which would set us back a few decades but not to the stone age), then the losses would be almost completely absorbed by equity, with stocks losing most of their value.

In an event like this that wipes out equity, wouldn't those companies still be around though, so that those few decades later your stocks would be worth something again? If your index funds actually lost all value and became valueless for now and the future, wouldn't that mean that those companies completely imploded? And even then, wouldn't vanguard switch over all of your shares to the new VTSAX group that was left after everything else imploded?

dmn

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Re: Never reallocating away from 100% equity with age?
« Reply #34 on: June 13, 2014, 09:29:37 AM »
In an event like this that wipes out equity, wouldn't those companies still be around though, so that those few decades later your stocks would be worth something again? If your index funds actually lost all value and became valueless for now and the future, wouldn't that mean that those companies completely imploded? And even then, wouldn't vanguard switch over all of your shares to the new VTSAX group that was left after everything else imploded?
No, if the equity is completely wiped out the company can continue to operate, and ownership goes to the creditors, e.g. bond owners.

As an example, consider General Motors. Their assets are financed by 26% equity and 74% corporate debt. When GM loses 30% of its assets, equity goes to zero, and GM has to file bankruptcy. Your stocks are wiped out, because the assets are worth less than the corporate debt. You are now out of the game, and the remaining assets are completely owned by the creditors. The creditors may decide to continue operating the company. If the company improves afterwards, your stocks don't come back, as the creditors own the entire business now.

Quoting Wikipedia (emphasis added):
Quote
Debt for equity deals often occur when large companies run into serious financial trouble, and often result in these companies being taken over by their principal creditors. [...] As a consequence, the original shareholders' stake in the company is generally significantly diluted in these deals and may be entirely eliminated, as is typical in a Chapter 11 bankruptcy.

Stocks are, by construction, more risky than bonds, because in a crisis, equity investors lose their entire investment before a bond holder loses even the first cent.

matchewed

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Re: Never reallocating away from 100% equity with age?
« Reply #35 on: June 13, 2014, 09:32:38 AM »
wjbatman do you have a link to Pfau's paper that makes that claim?

The link PencilMustache provided has figures based not on current data but on current time frame. Making the assumption that tomorrow will look exactly like today. So you will get two different answers if the answer to what will tomorrow look like is answered as a) like historical, or at least not as bad as historical (the Trinity Study), or b) like today's environment.

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Re: Never reallocating away from 100% equity with age?
« Reply #36 on: June 13, 2014, 09:47:47 AM »
Perhaps he was referencing this paper: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2201323
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Re: Never reallocating away from 100% equity with age?
« Reply #37 on: June 13, 2014, 10:17:45 AM »
Perhaps he was referencing this paper: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2201323

I think that's the same one PencilMustache linked. Yeah it's the same scenario I described. It's not a debunking of the 4% rule just a study saying that if the future is identical to today it doesn't work. It even uses negative bond returns for the next five years. Basically if everything is going to shit right when you FIRE you run the risk of not succeeding. He does revert back to historical returns after the five year period but from what I'm reading it still uses conservative equity return of 6%. The paper seems to be more of an answer to the question of what happens if bonds remain a poor investment for the foreseeable future. He has some great points in it as to why he and the other authors expect bonds to do poorly.

I'd just like to differentiate between the Trinity Study and the paper we're talking about. In fact in 2009 Wade did update the Trinity study - here. And the 4% rule still worked 98% of the time for a 75/25 equity/bond AA. In 2011 the Trinity study was updated and Wade has a great breakdown on it here.

Much like it has been repeated on this board, during those first few years of being FIRE it is very important to be flexible and cognizant that the 4% rule is a guideline. Your particular circumstances may be different when you FIRE. That's the main takeaway I have from Wade's writings. It is very educational.

I like Pfau's research a great deal. It's well thought out and meticulous. He makes some very conservative assumptions which is good because this is stuff meant for financial planners, I'd probably take a more conservative approach if it wasn't my money too. I'll stick to my optimism gun on this one though.

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Re: Never reallocating away from 100% equity with age?
« Reply #38 on: June 13, 2014, 12:01:03 PM »
Stocks are, by construction, more risky than bonds, because in a crisis, equity investors lose their entire investment before a bond holder loses even the first cent.

As you can see, I don't know a lot about this kind of eventuality. In your opinion, how bad of an event would cause enough of these companies to go under to ruin someone who was 100% VTSAX? Are we talking about rioting in the streets? Also, what would a bonds fund from Vanguard look like in this kind of event? A lot of the companies in VTSAX have significant international branches (and as Jim Collins points out, this gives you pretty good international exposure and diversification), what effect would this have globally if this significant amount of companies turns belly up?

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Re: Never reallocating away from 100% equity with age?
« Reply #39 on: June 13, 2014, 02:28:01 PM »
matchewed, I was referencing Wade Pfau's blog post you linked (http://wpfau.blogspot.com/2010/10/trinity-study-retirement-withdrawal.html)

I'm far from the doom and gloom type, I just thought it was interesting comparing the huge differences in the two studies. On one hand the original Trinity study from 1996 showing a 6% withdrawal rate over 30 years would be 100% successful, while Wade Pfau's work from 2010 shows it's impossible to achieve a 100% success rate with anything above a 3% withdrawal rate. Of course, newer research that has been linked in this thread shows different results.

As much as the topic of market timing is taboo here, I think it's clear that when you begin your retirement as just as important as what percentage you withdraw every year.

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Re: Never reallocating away from 100% equity with age?
« Reply #40 on: June 13, 2014, 02:45:25 PM »
matchewed, I was referencing Wade Pfau's blog post you linked (http://wpfau.blogspot.com/2010/10/trinity-study-retirement-withdrawal.html)

I'm far from the doom and gloom type, I just thought it was interesting comparing the huge differences in the two studies. On one hand the original Trinity study from 1996 showing a 6% withdrawal rate over 30 years would be 100% successful, while Wade Pfau's work from 2010 shows it's impossible to achieve a 100% success rate with anything above a 3% withdrawal rate. Of course, newer research that has been linked in this thread shows different results.

As much as the topic of market timing is taboo here, I think it's clear that when you begin your retirement as just as important as what percentage you withdraw every year.

I couldn't agree more on your last point. Understanding the economic variables is just as important as understanding your investments when you FIRE. Good thing we've got this 5-10+ year time frame to learn all these fun things. :D

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Re: Never reallocating away from 100% equity with age?
« Reply #41 on: June 13, 2014, 05:23:34 PM »
http://wpfau.blogspot.com/2011/04/trinity-study-updates.html is the updated.

Trinity never said 6% was safe.  Heck the whole point of the study was to debunk the 6%+ recommendations (after all a 60/40 port returns 9%. Take 3 out for inflation and 6% should be good). It is important to note the limitations. It used US only (good: high return bad: well they were low return when the 1966 people need them) and large cap (through in small caps and historically you could have gotten t.5% return). Your portfolio might differ

Picking a bad retirement date dooms you to 3-3.5% SWR. Pick a good one and 7/8% is pretty reasonable. The good news is that you will know what curve you are on after 10-15 years or so. Bad news if you start at 4% and you need to be at 3%, your in trouble. The good news is that those cases tend to show up much earlier (i.e. the 1966 retiree hit 2 bear markets early on).



matchewed, I was referencing Wade Pfau's blog post you linked (http://wpfau.blogspot.com/2010/10/trinity-study-retirement-withdrawal.html)

I'm far from the doom and gloom type, I just thought it was interesting comparing the huge differences in the two studies. On one hand the original Trinity study from 1996 showing a 6% withdrawal rate over 30 years would be 100% successful, while Wade Pfau's work from 2010 shows it's impossible to achieve a 100% success rate with anything above a 3% withdrawal rate. Of course, newer research that has been linked in this thread shows different results.

As much as the topic of market timing is taboo here, I think it's clear that when you begin your retirement as just as important as what percentage you withdraw every year.

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Re: Never reallocating away from 100% equity with age?
« Reply #42 on: June 13, 2014, 06:05:12 PM »
Trinity never said 6% was safe.

Actually, yes, it does. Take a look if you don't believe me. Like I've said before, the original Trinity study claims, based on the 1926-1995 time frame, that a 25% stock/75% bonds portfolio can sustain a 6% withdrawal rate for 30 years with a 100% success rate. Within that same study, based on the 1946-1995 time frame, three allocations support a 7% withdrawal rate for 30 years (100/0, 75/25, 50/50).

Anyway, the study is hilarious to read now, considering where we are at.

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Re: Never reallocating away from 100% equity with age?
« Reply #43 on: June 13, 2014, 06:45:54 PM »
Trinity never said 6% was safe.

Actually, yes, it does. Take a look if you don't believe me. Like I've said before, the original Trinity study claims, based on the 1926-1995 time frame, that a 25% stock/75% bonds portfolio can sustain a 6% withdrawal rate for 30 years with a 100% success rate.

...what?  I'm not sure you're reading it right...

If I look at table 3 (the inflation adjusted one, that everyone references, I.e. You adjust your withdrawals for inflation each year), look at 25/75, 30 years, 6% WR, I see a success rate of 20%, not 100%, as you claim.

(And sure, if you never adjust your withdrawals for inflation of course you can have a much larger withdrawal rate be successful, as shown in the first two tables).

Pfau has been refining their work, not blowing it up.  The trinity study is still pretty darn accurate, just updated now with almost two more decades of data including two major stock market crashes.  It' still pretty accurate overall.

I think you're just misreading it, and apparently have in the past if you've said this before.
« Last Edit: June 13, 2014, 06:49:27 PM by arebelspy »
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Re: Never reallocating away from 100% equity with age?
« Reply #44 on: June 13, 2014, 06:59:15 PM »
...what?  I'm not sure you're reading it right...

If I look at table 3 (the inflation adjusted one, that everyone references, I.e. You adjust your withdrawals for inflation each year), look at 25/75, 30 years, 6% WR, I see a success rate of 20%, not 100%, as you claim.

(And sure, if you never adjust your withdrawals for inflation of course you can have a much larger withdrawal rate be successful, as shown in the first two tables).
Yep, seems like he's looking at Table 1, which doesn't adjust withdrawals to inflation.

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Re: Never reallocating away from 100% equity with age?
« Reply #45 on: June 14, 2014, 05:21:15 AM »
No, I wasn't adjusting for inflation. Where did I say I was?

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Re: Never reallocating away from 100% equity with age?
« Reply #46 on: June 14, 2014, 06:08:16 AM »
No, I wasn't adjusting for inflation. Where did I say I was?
Well, when we talk about SWRs, at least on this forum, it's implied that you index your withdrawal for inflation. If you mean otherwise, you have to specify that, because people will read it and assume you mean inflation-adjusted. A retirement plan which makes a constant nominal withdrawal (i.e. doesn't adjust for inflation) is unfit for purpose, especially over longer retirement periods which early retirees expect. Also, you can't really say a 6% non-inflation-adjusted withdrawal plan is ridiculously unsafe just by comparison to the maximum safe inflation-adjusted plan of 4%, and it certainly seemed like you were making that comparison.

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Re: Never reallocating away from 100% equity with age?
« Reply #47 on: June 14, 2014, 09:28:31 AM »
No, I wasn't adjusting for inflation. Where did I say I was?

To be honest, at this point it seems like you read the wrong chart and are now trying to cover yourself so you don't appear silly.  But now you appear even more ridiculous with this claim.  It'd be better to just say "whoops!  read the wrong chart!"

If I'm mistaken on that, my bad, but who talks about non-inflation adjusted spending, ever?  And then to claim you were talking about non inflation adjusted spending, but just didn't mention it?

"On a 1MM portfolio, I'm going to start spending $60k, a 6% SWR, and never increase it with inflation, so that 30 years later I'll still be spending exactly 60k (though my buying power will at least have halved, so it's more like 20-30k real dollars), and I'll then have been safe 100% of the time."

That's the scenario you were talking about?  Really?

You were also saying it was ridiculous, and comparing it to Pfau's work.  But Pfau's was inflation adjusted.  That's why it was ridiculous, what you were comparing.  The Trinity study, like I said, is still pretty darn accurate, Pfau's just refined it.  Your claim of 6% indefinitely being safe versus 4% not is false, if we take the 4% to not be inflation adjusted, same as you (apparently claim) you were with the 6%.

It's okay to read a chart wrong, when I first opened the PDF I was confused as to why those were the results as well, until I realized there was no COLA. :)
« Last Edit: June 14, 2014, 09:30:59 AM by arebelspy »
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Re: Never reallocating away from 100% equity with age?
« Reply #48 on: June 16, 2014, 01:27:47 PM »
No, I wasn't adjusting for inflation. Where did I say I was?

To be honest, at this point it seems like you read the wrong chart and are now trying to cover yourself so you don't appear silly.  But now you appear even more ridiculous with this claim.  It'd be better to just say "whoops!  read the wrong chart!"

If I'm mistaken on that, my bad, but who talks about non-inflation adjusted spending, ever?  And then to claim you were talking about non inflation adjusted spending, but just didn't mention it?

"On a 1MM portfolio, I'm going to start spending $60k, a 6% SWR, and never increase it with inflation, so that 30 years later I'll still be spending exactly 60k (though my buying power will at least have halved, so it's more like 20-30k real dollars), and I'll then have been safe 100% of the time."

That's the scenario you were talking about?  Really?

You were also saying it was ridiculous, and comparing it to Pfau's work.  But Pfau's was inflation adjusted.  That's why it was ridiculous, what you were comparing.  The Trinity study, like I said, is still pretty darn accurate, Pfau's just refined it.  Your claim of 6% indefinitely being safe versus 4% not is false, if we take the 4% to not be inflation adjusted, same as you (apparently claim) you were with the 6%.

It's okay to read a chart wrong, when I first opened the PDF I was confused as to why those were the results as well, until I realized there was no COLA. :)

Well the study authors definitely considered the non adjusted strategy.  They made a whole table on it and everything!

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Re: Never reallocating away from 100% equity with age?
« Reply #49 on: June 16, 2014, 03:07:41 PM »
The study authors evidently weren't thinking about early retirement at all. They considered retirement periods 10, 20 and 30 years long. 30 years isn't very long on this forum.