A Rich Life

The Old Ideas on Saving & Investing Don't Work -- Here's What Does

“Someone Had Already Created the Tools I Had Daydreamed About Having!”

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Set forth below is the text of an e-mail that I recently received from Bjorn Amundson, a Certified Financial Planner, followed by my response:

Rob:

Thanks so much for all the work you do and your great calculators on your site!

I stumbled onto Shiller’s study probably 2 years ago.  I was instantly struck with the huge implications it had for my work as a financial planner.  Even better, I found out that someone had already gone and done all the legwork I imagined doing and creating the tools I had daydreamed about having!

I’ve been at too many places that love the 4-5% rule.  The inherent contradiction in this rule (or trap) is that if you can spend 5% no matter what year you retire, then if the stock market goes up a lot, then you can “reset” your spending rate at this new 20% higher rate!  So, spending goes up with the stock market returns, but…then …isn’t supposed to go down with it….

The next level of your calulators/ideas will be applying this across different markets as well.  Imagine if Australia is at a PE10 of 9 while the US is at 25 or something.  I’ve searched the web far and wide and have had a VERY difficult time coming up with international data…Do you know of any?

Also, I have spent a long time creating a formula that adjusts allocation according to the PE10 raio as well.  It historically outperforms the market (no shocker)with less volitility.  However, it doesn’t work in all decades and is primarily useful at the extreme margins.

Anyways, thanks again and I’ll keep reading your stuff.

Bjorn

Bjorn:

Thanks for your kind words and for your interest in my work.

There’s not a lot of international material. I believe that the problem is that a market needs to be stable for some time for predictions to work. This won’t work for emerging markets or for markets in dying economies. Chapter Six of Shiller’s “Irrational Exuberance” book is titled “New Eras and Bubbles Around the World.” That gives a bit of information about foreign markets but not a great deal.

Here are four links to discussion threads at the SWR Research Group board that make reference to international questions. It might be that you would come across some useful references by checking these out:

http://s162532268.onlinehome.us/Sewer/viewtopic.php?t=1016&highlight=international

http://s162532268.onlinehome.us/Sewer/viewtopic.php?t=1144&highlight=international

http://s162532268.onlinehome.us/Sewer/viewtopic.php?t=1153&highlight=international

http://s162532268.onlinehome.us/Sewer/viewtopic.php?t=1202&highlight=international

You are absolutely right about the logic flaw in having SWR resets go only in one direction. The insanity of this drives me crazy. There are lots of otherwise smart people who think it makes sense to proceed in this way, however.

John Walter Russell tested some switching formulas at his www.Early-Retirement-Planning-Insights.com site. It certainly can be a stimulating intellectual exercise to do this. However, I personally don’t think that all answers can ever be obtained from formulas. One problem is that the return available from super-safe asset classes is ever-changing. In some circumstances, it might be worth investing heavily in stocks selling at a certain P/E10 level and in other circumstances this would not be so. There are several different moving pieces in this puzzle. I certainly wish you the best of luck with your efforts in this regard, however, and would always be interested in knowing how things turn out.

Thanks for your feedback and questions. I hope that we will be back in touch from time to time.

Rob

ValueWalk.com Article #4 — What If You Don’t Want to Die Broke?

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The www.ValueWalk.com site has posted my article entitled The Retirement Risk Evaluator: Part Three — What If You Don’t Want to Die Broke?

Juicy Excerpt: A demand that 100 percent of the portfolio balance remain at Year 30 reduces the safe withdrawal rate by less than one full percentage point! Insisting that your portfolio retain its value delays your retirement date, as would be expected. But the cost of insisting that a significant percentage of your starting-point portfolio value be retained or even the entire starting-point portfolio value be retained is much less than the cost that is incurred by failing to take valuations into consideration. The conventional retirement planning guidance is failing to provide retirees with valuable information about the tradeoffs that come into play when putting together a retirement plan.

Value Walk.com Article #3 — The Effect of Valuations on the Safe Withdrawal Rate

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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.

ValueWalk.com Article #2 — Why We Need a New Type of Retirement Calculator

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The www.ValueWalk.com site today published my article entitled The Retirement Risk Evaluator: Part One — Why We Need a New Type of Retirement Calculator.

Juicy Excerpt #1: It is true that the historical record does not today contain a returns sequence in which a retirement plan calling for a 4 percent withdrawal failed within 30 years. However, this reality should offer small comfort to retirees who took withdrawals for retirements beginning at the valuation levels that have applied since 1996. From 1900 forward, there have been only two cases in which we have seen the insane levels of overvaluation that applied from January 1996 through September 2008. In each of those two cases, retirements calling for a 4 percent withdrawal came within a whisker of falling. The fact that 4 percent withdrawals have come close to failing in both of the two cases in which they were attempted for retirements beginning at times of high valuations shows not that this withdrawal rate is safe in these circumstances but that it is risky in these circumstances.

Juicy Excerpt #2: The studies and calculators have not been fixed because fixing them would require a widespread public acknowledgment of the flaws of the popular Buy-and-Hold model for understanding how stock investing works. Buy-and-Hold was developed at a time of widespread confidence in the Efficient Market Theory, which posits that stocks are always priced more or less properly. Yale Professor Robert Shiller’s 1981 research showing that valuations affect long-term return challenges this belief (if stocks were always priced properly, the concept of overvaluation would be meaningless and valuations could not predict long-term returns). From 1981 through today, we have been living through a transition period in which the experts’ confidence in the Buy-and-Hold Model has been greatly diminished but in which most experts have felt too cowed by the continued popularity of Buy-and-Hold to develop alternative models more in accord with our new understanding of the message of the historical data.

Google Knol #4 — The First Retirement Calculator That Gets the Numbers Right

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I’ve posted my fourth Google Knol. It is called The First Retirement Calculator That Gets the Numbers Right.

Juicy Excerpt: The valuation level that applies on he day the retirement begins is  the single biggest factor bearing on the safety or lack thereof of the retirement plan. The Old School studies,  developed in accord with the premises of the Buy-and-Hold Model, ignore this factor. Thus, the studies get all the numbers wildly wrong. And the retirement calculators based on these studies also get all the numbers wrong. We need a newfangled sort of retirement calculator!