In the last post Existential Doc posed the question what to do? I went through how I would analyze it but a more formal presentation might be useful.
What would happen to survivability if the stock market dropped in half permanently? How does AA affect this? Lets start with the good old bogglehead triple fund. The triple is a 80% stocks 20% bonds fund of US stocks Global stocks and total bonds and if you used it as your retirement portfolio for 30 years and a 4% WR the probabilities would look like this:
82% survival for 30 years. I’m going to treat this as an 80/20 portfolio socks to bonds. Let’s say stocks fall in half. A 1M portfolio now becomes 200K in bonds and 400K in stocks so the portfolio is worth 600K and the AA is 67/34. Lets monte carlo that 67/34 portfolio using the same ratios and WR on the 600K principal
43% survive at 40K/yr WR. If you knock the WR down to 28K we are at 82% survival once again. So to survive a 50% equity hair cut using an 80/20 bogglehead at equal levels of survival and a 1M start you’re 40K/yr WR must drop to 28K/yr or a 30% cut. That’s almost 2500/mo. What about a 60/40 Stocks v bonds at 4% WR and 30 year horizon?
Just by changing the AA to 60 /40 and getting rid of foreign survivability goes to 96%. What happens if we loose 50% of the equities? on a 1M portfolio the bonds are 400K and the stocks are 300K, so you immediately start with an extra 100K in the bank compared to the BH3 example. The AA of that 700K is 43/57 stocks v bonds so lets MC that sucker 700K, 40K WR and a 43/57 AA
so a 40K WR on 700K drops survival to 70% What if we re-balance back to 60/40?
74% It helps a little, so let’s keep 60/40 and try reducing WR to 30K/yr
We see a 94% success at 30K/yr nearly the same as the original 96%.
So what does all this mean? It’s how you plan. What do you do if you loose 1/3 of your money? What do you do before you loose your money? We saw what happened to a typical 80/20 portfolio not on the efficient frontier. WE saw what happened to a safer 60/40 portfolio on the efficient frontier, and we saw the survival rates. To get the bogglehead 3 to 92% survival required dropping the WR from 40K/yr to 19K/yr after the disastrous loss.
The other thing that matters is when SS kicks in. If you are close to SS when the disaster hits you are largely immunized. If you are far away from SS because you retired early…