The Value Walk site has posted my article entitled The Retirement Risk Evaluator: Part Two — The Effect of Valuations on the Safe Withdrawal Rate.
Juicy Excerpt: At this valuation level, the safe withdrawal rate drops with increases in the stock allocation, moving from a high of 3.9 at a 20 percent stock allocation to a low of 3.1 at an 80 percent stock allocation. While this result is in accord with the conventional idea that adding stocks to a portfolio increases the risk associated with the portfolio, it does not offer support for the conventional explanation of why this is so. The conventional idea is that stocks are more risky because they provide higher returns (the theory is that investors are being compensated for being willing to take on added risk). The data shows the safe withdrawal rate dropping as the stock allocation goes higher (in cases in which the valuation level is high) because returns being generated are poor! Investors are not rewarded for taking on the added risk that comes with investing heavily in stocks at times of high valuations, according to the Risk Evaluator. They are penalized! We need to begin examining the concept of an Equity Risk Penalty.
The conventional idea is that stocks are more risky because they provide higher returns
No, you have it exactly backwards. They provide higher returns because they are more risky.
Stocks have never been as risky as they were in January 2000, Evidence.
Is it your understanding that the returns from January 2000 forward have been the highest on record?
Why were those investors not compensated for taking on insane levels of risk?
Because it is all mumbo-jumbo. Buy-and-Hold is Get Rich Quick. Get Rich Quick never turns out well for long-term investors.
Rob
Is it your understanding that the returns from January 2000 forward have been the highest on record?
No.
Why were those investors not compensated for taking on insane levels of risk?
Because that is the meaning of the word risk, the rewards are not certain.
[i]Because that is the meaning of the word risk, the rewards are not certain.[/i]
Do you agree with me that the risk associated with stock investing was far greater than normal in 2000?
Or do you believe that it is impossible to say when the risk is greater and that for purposes of setting your stock allocation at any given time you just have to assume that the normal risk level applies? It is my understanding that this latter position is the Buy-and-Hold position.
Rob
Sometimes stocks are risky when prices are low…right before they go to zero.
We’re talking about index investing, Sadface.
If the price of the entire U.S. market goes to zero, I have a funny hunch that you are going to have one or two worries on your mind bigger than any concern you will be feeling about what has happened to your stock portfolio.
The U.S. market has of course never once in its history gone to zero. The lowest it has ever gone is to one-half of fair value. And it has only gone to one-half of fair value in the wake of insane bull markets. There has never been a time when Buy-and-Hold had not been widely promoted that U.S. stock prices went down to anything close to one-half fair value.
Bury Buy-and-Hold 30 feet in the ground, where it can do no further harm to humans and other living things, and you bury concerns about the U.S. market going to one-half fair value or even lower 30 feet in the ground with it.
The only question on my mind is — Is there anything that I could be doing to make this happen sooner that I am not today doing? Given the importance of achieving the goal to so many of my friends and co-workers and neighbors and fellow community members, am I working it hard enough? We all have to consider that question and answer that question in our own minds.
My take.
Rob
Given the importance of achieving the goal to so many of my friends and co-workers and neighbors and fellow community members, am I working it hard enough?
I think you are working it hard enough Rob, I don’t believe you are working it smart enough.
You have any extra I.Q points you’re willing to lend me, Evidence?
You gotta go with what you got. No?
Rob
What a strange strategy.
So, you maintained a 60% stock portfolio, then stock values went up…so you bought more stock (80% allocation)?
This seems backwards and I am 🙁 that you are blindly following this concept. You might want to try under weighting the oldest years in your PE10 calculation, otherwise crazy years like 1999 will affect your investing decisions when the values of 1999 are no longer relevant at all.
So, you maintained a 60% stock portfolio, then stock values went up…so you bought more stock (80% allocation)? This seems backwards
It seems backwards to you because the way you are describing it is backwards. My strong hunch is that that is intentional on your part, Sadface. I say this because I have seen you make this same sort of “mistake” over and over and over and over again. To what constructive purpose, Sadface? Why not try to learn?
If you want to learn, you can learn. The materials are here for you just as they are for anyone else. But we cannot get you started moving in the right direction until you develop the ability to acknowledge having been wrong in thinking that the Get Rich Quick/Buy-and-Hold approach could work. You’re going to have to leave that one behind, Sadface. There’s no other way to make progress.
There are lots of smart people who made the same mistake. I see no great shame in acknowledging it. The shame is in sticking with something that has been discredited and with willfully closing your eyes to its flaws. It’s not the original mistake that is causing you troubles. It is the cover-up of the cover-up of the cover-up.
Please fix!
You might want to try under weighting the oldest years in your PE10 calculation, otherwise crazy years like 1999 will affect your investing decisions when the values of 1999 are no longer relevant at all.
This one appears to be the result of a genuine misunderstanding. That’s something different. It is helpful for you to bring up this point as this is something that I think could confuse a lot of people making a sincere effort to understand the realities of stock investing.
We don’t want to exclude “crazy” years from the P/E10 calculation, Sadface. The entire idea of using the average of 10 years of earnings rather than a single year of earnings (as is done with the more frequently used valuation metric “P/E1”) is to get a mix of average sorts of years, crazy years on the high side and crazy years on the low side. If you start taking some years out on the mix on grounds that they are crazy, you’re going to lose the balance that comes from having 10 consecutive years in the mix. So it would be defeating your purpose to do this.
One “crazy” year does not have much effect on a 10-year average. Including the “crazy” year does not do any harm, Sadface. And please note that you are NOT using the price from 1999 (which really was totally bonkers off-the-wall crazy!). Your price number is the current-year number, not a 10-year average.
But, again, that one was indeed a good question and I am grateful to you for bringing it up.
Rob