Withdrawal Rates, Savings Rates, and Valuation-Based Asset Allocation

Pfau, Wade Donald (2011): Withdrawal Rates, Savings Rates, and Valuation-Based Asset Allocation.

Abstract

While most everyone would agree that valuations matter, the question remains as to whether clients with a long-term outlook (such as those planning for retirement) can hope to act successfully on information about valuations. This article provides favorable evidence based on the historical record for long-term conservative investors to obtain improved retirement planning outcomes (lower savings rates, higher withdrawal rates) using valuation-based asset allocation strategies. This is illustrated with a specific example comparing a 50/50 fixed allocation strategy to a Graham and Dodd inspired valuation-based strategy with a stock allocation of 25, 50, or 75% determined by the value of the cyclically-adjusted price-earnings ratio with respect to its median value up to that point in history. Important caveats are discussed. But even if clients or advisors decide against adopting valuation-based asset allocation, advisors may at least be able to use the findings of this research to help persuade clients to stay the course and not give in to the temptation to change their asset allocations in the “wrong direction,” such as increasing stock holdings after valuations rise or panicking and selling stocks after a plummet in valuations.

• Item Type: MPRA Paper
• Language: English
• Keywords: market valuations; cyclically-adjusted price-earnings ratio; PE10; stock returns; asset allocation; retirement planning
• Subjects: G - Financial Economics > G1 - General Financial Markets > G14 - Information and Market Efficiency ; Event Studies ; Insider Trading; G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; N - Economic History > N2 - Financial Markets and Institutions > N22 - U.S. ; Canada: 1913-; C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C15 - Statistical Simulation Methods: General; D - Microeconomics > D1 - Household Behavior and Family Economics > D14 - Household Saving; Personal Finance

References

Bengen, William P. 1994. “Determining Withdrawal Rates Using Historical Data.” Journal of Financial Planning 7, 4 (October): 171-180.

Blanchett, David. 2011. “Is Buy and Hold Dead? Exploring the Costs of Tactical Reallocation.” Journal of Financial Planning 24, 2 (February): 54-61.

Campbell, John Y., and Robert J. Shiller. 1998. "Valuation Ratios and the Long-Run Stock Market Outlook." Journal of Portfolio Management 24, 2 (Winter): 11-26.

Fisher, Kenneth L., and Meir Statman. 2006. “Market Timing in Regression and Reality.” Journal of Financial Research 29, 3 (Fall): 293-304.

Graham, Benjamin, and David Dodd. 1940. Security Analysis (The Classic 1940 Second Edition). New York: McGraw-Hill.

Jenkins, David. 1961. How to Profit From Formula Plans in the Stock Market. Larchmont, NY: American Research Council.

Kitces, Michael E. 2008. "Resolving the Paradox - Is the Safe Withdrawal Rate Sometimes Too Safe?" The Kitces Report (May).

Kitces, Michael E. 2009. “Dynamic Asset Allocation and Safe Withdrawal Rates” The Kitces Report (April).

Pfau, Wade D. 2011a. “Safe Savings Rates: A New Approach to Retirement Planning over the Life Cycle.” Journal of Financial Planning 24, 5 (May): 42-50.

Pfau, Wade D. 2011b. “Can We Predict the Sustainable Withdrawal Rate for New Retirees?” Journal of Financial Planning 24, 8 (August): 40-47.

Pfau, Wade D. 2012. “Long-Term Investors and Valuation-Based Asset Allocation.” Applied Financial Economics, forthcoming.

Ritchlin, Lance. 2011. “William Bengen on Risk, Volatility, and Safe Withdrawal Rates in Today’s Markets.” Journal of Financial Planning 24, 12 (December): 18-20.

Shiller, Robert J. 2000. Irrational Exhuberance. 2nd Edition. New York: Currency Doubleday.

Shiller, Robert J. 2010. “Irrational Exuberance Revisited.” Behavioral Finance and Investment Management. Edited by Arnold S. Wood. Charlottesville: Research Foundation of the CFA Institute.

Smithers, Andrew, and Stephen Wright. 2000. Valuing Wall Street: Protecting Wealth in Turbulent Markets. New York: McGraw-Hill.

Solow, Kenneth, R., Michael E. Kitces, and Sauro Locatelli. 2011. “Improving Risk-Adjusted Returns using Market-Valuation-Based Tactical Asset Allocation Strategies.” Journal of Financial Planning 24, 12 (Deember): 38-49.

Stein, Ben, and Phil DeMuth. 2003. Yes, You Can Time the Market. Hoboken: John Wiley and Sons.

Tomlinson, Lucille. 1953. Practical Formulas for Successful Investing. New York: Wilfred Funk.