Heaths:

“Once again, I said a lot, but really said nothing? ;o),

It's just my thoughts.

Ask your questions you might have, and maybe we can work through them.”

Chin I appreciate your long response, but I am still a bit confused.  First both you and Stats seem to say that the only test is the sleep test.  I guess that would mean that any percentage of equities would work if you could sleep well at night.  Please correct me if I am wrong, but I don’t think that either of you mean to say that.

You originally said that the greatest and only dependable diversification is in the stocks/fixed allocations (and possibly commodities).  Your latest post primarily focuses on other forms of diversification that presumably are not dependable, so I would like to return to the specific discussion of the stocks/fixed allocation.

To help quantify the stocks/fixed allocation you suggested, “You can look back at history, and consider the Crash of ‘29 and what kind of risk you can take on depleting your portfolio in the event you need to draw on it right at the time the market takes a dive such as this.”  You then added, “we might consider inflation our worst enemy going forward -- something like 1973 - 1982. During this period, when the S&P hadn't really reached bubble valuations, small, value, international and REITs still helped stocks represented by the S&P 500 (large blend) lost 60% real over a 10 year period.”  You then further qualified, “It also has to do with whether or not you think something like 1929 is likely to happen again, or you can depend on historic numbers to create a likely scenario at all.”

I suppose this means that the past declines of the market could happen again, but on the other hand, the future may never be that bad or that it could be even worse.  Assuming that other forms of diversification might be helpful, but are not dependable, what do ’29 and ’73-’82 (and the general lack of dependability of historic numbers) tell us about the stocks/fixed allocations generally, and more specifically for a retiree? 

Hi Heaths,

All it does is give you some scenarios to look at; and idea of what could happen. Each of those bear markets, as well as the more recent 2000 - 2002 were all different. There is no reason to believe the next set of data we look at will be anything like either of those sets.

Somewhere in there, I think I said something to the nature of "It becomes a thinking game."

You can't blindly follow the Monte Carlo Analysis, and you can't blindly follow the historic data and what happened.

The 4% Safe Withdrawal Rate is actually a little more than half of what was offered prior to those such as William Bernstein pointing out the flaws in the retirement calculators.

What I am offering is to go with the 4% and diversify, but do not think that because you diversify, you can increase the SWR as some have shown from using numbers that do reflect the more recent inflation fears; unless you think it impossible we could see another depression. I am also saying don't place too much faith in the Efficient Frontier as offered by those who claim they can punch numbers into a little black box and spit out the Optimal Portfolio.

Every bear market that has threatened our portfolios has been different, and there is no reason for us to believe the next one will look anything like the last. However, looking back at what happened offers us some ideas of what to look out for.

I'm saying no matter your portfolio, 60/40 for the higher risk portfolio, looked to be about the highest you would want to go with stocks -- in the attempt to gain better returns going forward, and not deplete your portfolio in the process. If you think you can depend on a time period in which you can predict you will live going forward, you can reduce stocks to offer more safety, but this in itself might be dangerous as well.

This was all an answer to your question, "Your rule of thumb is a 50% short-term stock loss. What does short-term mean and why should I be concerned over something that is only short term? How do I use this rule of thumb to help quantify my stocks/fixed income allocations?"

If you are going to use S&P 500 or TSM and 10 yr. treasuries, you can go with the Trinity study, ‘If' you trust the MCS, but even at a 98% success rate and a 3.8% SWR, you are looking at a 1:50 chance you will not make it through the 30 years.

My thoughts are you diversify out to try to get rid of these risks as much as possible, and you consider all possibilities. You can't use data going back to 1970 to quantify what happened in ‘29, and you can't depend on the idea that risk can be measured by standard deviation, and you can't depend on any bear market to look like the last three.

You should cover yourself as much as possible, and even at that, you should leave room in your retirement income to be flexible.

My 60/40 is a guess. It is a rule of thumb, just as the 4% SWR is a rule of thumb.

I feel comfortable with it, but I wouldn't advise anyone else to use my rule of thumb. They may want to go 50/50, 40/60, and maybe 3%, or even as low as 2%.

The one thing I would advise is not to go 5% on the SWR. That is pushing your luck a bit too far.

Edited to add;

When I say more risky portfolio, I do not mean per the Efficient Frontier or EMH. I mean that looking at the SWR for 1929, with the 4x25, you needed to add more in bonds than with the S&P 500 -- ‘29 being the worst case scenario we have seen.

Chin