Set forth below is the text of a comment that I recently posted to the discussion thread for another blog entry at this site:
It matters when it comes. If it takes 60 years and stocks only use 50% of their value there is no way you will ever catch up due to lose compounding.
145 backwards looking years are irrelevant. The next 40 years is what matters for the current generation.
The basic point that you are making here is legitimate, Laugh.
It obviously is true that what you care about is the next 40 years, not the past 145 years. The problem, of course, is that none of us knows what the next 40 years will bring. We look to the last 145 years of returns for guidance re that question. There have been lots of different types of scenarios that have played out over the past 145 years. The most realistic assumption is that something at least generally along the lines of one of the scenarios that we have seen play out in the past is what we will play out in the future.
If you are confident that we will see something different in the future than what we ever seen in the past, it’s fine to go with that belief. But if you are offering advice to others that is rooted in that belief, you need to let them know that that’s the case. The Buy-and-Hold retirement studies said that a 4 percent withdrawal was safe for retirements in which the historical return data showed that no withdrawal greater than 1.6 percent was safe. That’s fraud when it is done knowingly and it is error even when it is done as the result of cognitive dissonance. If you say “presuming that stocks perform in the future in a way in which they never have in the past have performed, then 4 percent is safe,” that’s on the right side of the line. The Buy-and-Holders don’t do that. They claim that there is data supporting their crazy claim that the safe withdrawal rate is always the same number. That’s fraud (not knowing fraud in cases where cognitive dissonance rules, but still).
There ARE scenarios where the Valuation-Informed Indexer fails behind because overvaluation remains in place longer than anticipated and then cannot catch up because he has missed out on compounding returns. These cases are rare. They constitute about 10 percent of the scenarios that can be generated using the 145 years of historical return data available to us. Investors do need to know about this possibility. It would be wrong to hide this reality from them.
Still, we are talking about a 10 percent possibility. There is a 90 percent possibility that the VII investor will end up ahead in the long run. And, in the 90 percent of cases in which the VII investors ends up ahead, he usually ends up FAR ahead while, in the 10 percent of cases in which he ends up behind, he is usually behind by just a little. Investors have no way of knowing in advance whether one of these rare scenarios is going to play out or not. So I think it is fair to say that VII always offer the better risk-adjusted long-term return. The Buy-and-Hold investor occasionally will end up ahead but he takes on far more risk in gaining that slight chance of ending up ahead.
Does that help?
Rob
Have you noticed that your site has been gradually falling apart? For weeks it hasn’t been caching correctly. The left and right columns got pushed to the bottom, then dropped altogether. And now your smiling face is missing from the banner. That’s where we draw the line!
Isn’t it fraud to say 4% won’t work? After all, you have admitted that predictions fail.
I know that there are problems. I have spoken to a tech person about it but we have not yet managed to fix the problem.
Please wish me luck!
Rob
No predictions are made in the calculation of the safe withdrawal rate. The return scenarios that have applied in the historical record are considered and the withdrawal rate that barely works in the event that the worst-case return scenario happens to pop up starting from the valuation level that applies on the day the retirement begins is identified as the safe withdrawal rate.
The mistake that the Buy-and-Holders made was to consider only the one particular return scenario that happened to pop up in the historical record. For example, the highest valuation level we experienced prior to the late 1990s was the “33” that applied just prior to the onset of the crash of 1929. In that case, we saw a lucky return scenario pop up and a 4 percent withdrawal barely survived. However, the 4 percent withdrawal survived at that valuation level only in 50 percent of the return scenarios that we have seen in the historical record. There was a 50 percent chance that a retirement beginning in 1929 that used a 4 percent withdrawal rate would fail. A retirement with a 50 percent chance of failing is obviously not safe.
I don’t need to make any predictions to say that. I just look at the historical record. No predictions are needed because I choose the worst-case scenario. It is usually the case that a withdrawal rate not identified as “safe” has some chance of working out. I could predict that a lucky return scenario would pop up and that an unsafe withdrawal rate would in fact work out. But that’s not safe withdrawal rate analysis. The literature defines the concept as calling for examination of what happens in a worst-case scenario. It is because the investor is finding out what happens in a worst-case scenario that he views the withdrawal rate identified as a safe one.
I hope that helps a bit, Anonymous.
Rob