CAPE-based asset allocation strategy?

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HomerJ
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Re: CAPE-based asset allocation strategy?

Post by HomerJ » Sat May 11, 2019 4:34 pm

alex_686 wrote:
Sat May 11, 2019 3:22 pm
Second, my last post kind of hung of the your use of "rebalance". Every single rebalance strategy that I know of requires you to input expected market returns.
You'll have to explain that.

Rebalancing requires zero prediction of expected returns.

If I want to be 50/50, and I creep up to 55/45, I sell stocks, and buy bonds until I'm back to 50/50. There's zero looking at expected returns there. I'm just reacting to what's already happened, not what I think is going to happen.

Are you talking about CHANGING one's Asset Allocation, like the OP is suggesting? That's not rebalancing. Maybe we're misunderstanding terms.
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SovereignInvestor
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Re: CAPE-based asset allocation strategy?

Post by SovereignInvestor » Sat May 11, 2019 6:36 pm

alex_686 wrote:
Sat May 11, 2019 2:49 pm
SovereignInvestor wrote:
Sat May 11, 2019 2:13 pm
Statistics 101 says that to draw conclusions about a model especially determining fair value based on relative level of current CAPE to long term mean...we need to make sure the theoretical mean is stable across time.

...

A statistician should cringe at using CAPE with the huge bias that exists.
A couple of points here.

CAPE was not deigned to determine fair value. I don't know of any study that actually advocates using it as a fair value.

Next, let us look at returns. Equity returns are both mean reverting and time varying. That is, for a given period of the market will revert to a mean return. Then a structural or secular event occurs and the mean return changes. You can easily see this a priori but I don't know of anyway to see this a posteriori.

So let me once again say why I like it and make a statistical argument for it. It is intended as a way to estimate expected market returns. For this it works. You are not going to get good results if you use it for something different. Next, statically speaking, it is parsimonious. Often in models and statistics you can improve the accuracy of the model by adding more complexity and variables. However this has costs, for example including false correlations and overfitting. So you want your model to be parsimonious - the fewer the variables the better.
I'm glad you mentioned models bevause that's the core of the post.

The model I refer to to be clear is the regression with the dependent variable being 10yr or 20yr real returns and the independent variable being current CAPE.

The issue is the mean expected return for a given CAPE will be greater now in recent years than in older years because with the same prospective earnings power CAPE will be higher now than in older years due to buybacks, CPI changes, and tax reform.

I estimate the bias of CAPE in recent years to be about +30% over long term mean for the same earnings power.


Goodness of fit for model is all about ratio of signal to noise.

If there is a bias of 30% to the upside of CAPE, then it likely misses expected returns ovet 10 or 20 years by about 4 to 5 points. That is so much error that it overpowers any precision the model may have at capturing signals...that is to explain variation in returns related to variation in CAPE.

And yes adding adjustments to model like trending earnings for buybacks and maybe CPI + 1% anually may remove the bias of the mean for recent years but error around the adjustment adds to total error of model which increases the "noise". So bias would go near zero but total model error would increase which hurts predictive power.

I dont know how one can have any value of a model where the recent dat a is biased 30% higher IMO than older years when even a 10-20% difference in CAPE has big difference over long term returns. 30% is hugely significant and that noise will over power any signal the model otherwise would have.

The only way the model wold avoid being worthless by having so much noise via 30% bias IMO which is a huge variation, since Coefficient of variation of CAPE is probably less than 30%. The only way is if my thesis of the distortion is wrong and Im pretty sure it is not bevause I've never heard a response that haven't been refuted and several posters on here began to agree with the thesis espesically. buybacks how they create a bias up in CAPE given same earnings power ("all else equal") in recent years.

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HanSolo
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Re: CAPE-based asset allocation strategy?

Post by HanSolo » Sun May 12, 2019 9:46 am

alex_686 wrote:
Sat May 11, 2019 2:37 pm
HanSolo wrote:
Fri May 10, 2019 8:22 pm
In a 2015 article, Michael Kitces and Wade Pfau presented the results of an analysis that suggested some advantage in CAPE-based asset allocation:

https://www.aaii.com/journal/article/in ... allocation
This is a misrepresentation of the article on some key points. The context of the article is that we can use expected market returns - as estimated by CAPE - to generate a better withdrawal strategy in retirement. i.e., if CAPE is low, then expected equities return will be high, so one can have a high withdrawal rate.

I don't think this will help the OP on their strategy.
My statement was not a misrepresentation of anything. You are correct that the article focuses on asset allocation during retirement years, but Pfau is known to have written about valuation-based allocation generally, and the fact that this particular article applies the concept to retirement doesn't affect the fact that some analysis has been done on the effects of valuation-based allocation in investment portfolios generally. I can cite a different Pfau article if that will make you happy.

The more important point I wanted to get across was that assessing what's "high" or "low" in CAPE is not objective, and I think the Grantham articles I cited are insightful.

Let's let the OP decide whether or not any of this is helpful to the OP.

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siriusblack
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Re: CAPE-based asset allocation strategy?

Post by siriusblack » Mon May 13, 2019 6:06 pm

HanSolo wrote:
Sun May 12, 2019 9:46 am
alex_686 wrote:
Sat May 11, 2019 2:37 pm
HanSolo wrote:
Fri May 10, 2019 8:22 pm
In a 2015 article, Michael Kitces and Wade Pfau presented the results of an analysis that suggested some advantage in CAPE-based asset allocation:

https://www.aaii.com/journal/article/in ... allocation
This is a misrepresentation of the article on some key points. The context of the article is that we can use expected market returns - as estimated by CAPE - to generate a better withdrawal strategy in retirement. i.e., if CAPE is low, then expected equities return will be high, so one can have a high withdrawal rate.

I don't think this will help the OP on their strategy.
My statement was not a misrepresentation of anything. You are correct that the article focuses on asset allocation during retirement years, but Pfau is known to have written about valuation-based allocation generally, and the fact that this particular article applies the concept to retirement doesn't affect the fact that some analysis has been done on the effects of valuation-based allocation in investment portfolios generally. I can cite a different Pfau article if that will make you happy.

The more important point I wanted to get across was that assessing what's "high" or "low" in CAPE is not objective, and I think the Grantham articles I cited are insightful.

Let's let the OP decide whether or not any of this is helpful to the OP.
The referenced article seems applicable to the discussion from my POV. It's addressing the same basic question which is whether and to what extent market valuation levels can improve one's asset allocation strategy (using 3 simple categories- under valued, fairly valued, over valued... with well-defined, non-emotional rules for adjusting the AA, in this article it's 35%-45%-60%).

I think Table 3 is the key finding-- i.e. the valuation-based AA strategy did indeed outperform all other allocation strategies during the withdrawal phase of retirement. The effect is not huge ... but it's there. That syncs with my backtesting findings as well (i.e. small but positive effect, across numerous different time periods tested).

Coming back to the overall thesis -- I think it continues to hold true for me based on intuition combined with all the tests I've seen showing similar results. When market valuations are high (even if they end up staying high), the portfolio performance doesn't suffer much from reducing equity exposure. And conversely, downside risk is reduced (but not eliminated) at below-norm valuations, and therefore an investor with a stable risk tolerance can more confidently increase allocation to stocks, thus increasing risk-adjusted returns.

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Re: CAPE-based asset allocation strategy?

Post by SovereignInvestor » Tue May 14, 2019 7:27 am

siriusblack wrote:
Mon May 13, 2019 6:06 pm
HanSolo wrote:
Sun May 12, 2019 9:46 am
alex_686 wrote:
Sat May 11, 2019 2:37 pm
HanSolo wrote:
Fri May 10, 2019 8:22 pm
In a 2015 article, Michael Kitces and Wade Pfau presented the results of an analysis that suggested some advantage in CAPE-based asset allocation:

https://www.aaii.com/journal/article/in ... allocation
This is a misrepresentation of the article on some key points. The context of the article is that we can use expected market returns - as estimated by CAPE - to generate a better withdrawal strategy in retirement. i.e., if CAPE is low, then expected equities return will be high, so one can have a high withdrawal rate.

I don't think this will help the OP on their strategy.
My statement was not a misrepresentation of anything. You are correct that the article focuses on asset allocation during retirement years, but Pfau is known to have written about valuation-based allocation generally, and the fact that this particular article applies the concept to retirement doesn't affect the fact that some analysis has been done on the effects of valuation-based allocation in investment portfolios generally. I can cite a different Pfau article if that will make you happy.

The more important point I wanted to get across was that assessing what's "high" or "low" in CAPE is not objective, and I think the Grantham articles I cited are insightful.

Let's let the OP decide whether or not any of this is helpful to the OP.
The referenced article seems applicable to the discussion from my POV. It's addressing the same basic question which is whether and to what extent market valuation levels can improve one's asset allocation strategy (using 3 simple categories- under valued, fairly valued, over valued... with well-defined, non-emotional rules for adjusting the AA, in this article it's 35%-45%-60%).

I think Table 3 is the key finding-- i.e. the valuation-based AA strategy did indeed outperform all other allocation strategies during the withdrawal phase of retirement. The effect is not huge ... but it's there. That syncs with my backtesting findings as well (i.e. small but positive effect, across numerous different time periods tested).

Coming back to the overall thesis -- I think it continues to hold true for me based on intuition combined with all the tests I've seen showing similar results. When market valuations are high (even if they end up staying high), the portfolio performance doesn't suffer much from reducing equity exposure. And conversely, downside risk is reduced (but not eliminated) at below-norm valuations, and therefore an investor with a stable risk tolerance can more confidently increase allocation to stocks, thus increasing risk-adjusted returns.
The problem is this is rearview mirror and CAPE has serious inconcistency issues and won't hold up as well predicting returns as it has been off predicting 10 year returns for last 20 or so years.


Putting so much faith on past data then for consistency, it's analogous to suggesting to every person away from retirement to have 100% equities because they have nearly always outperformed bonds over 20 year periods.

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nedsaid
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Re: CAPE-based asset allocation strategy?

Post by nedsaid » Tue May 14, 2019 10:40 am

siriusblack wrote:
Thu May 09, 2019 11:16 am
Bogleheads,
I've been gravitating in my personal investing towards a CAPE-based asset allocation strategy. I'm wondering if anyone here is doing something similar, and/or if anyone here is aware of any good tools/methods for back-testing a CAPE-based asset allocation strategy?

(I've seen the Shiller PE asset allocation back-test at portfolio visualizer-- however, I don't like the #'s they used, and I don't see a good way to customize the rules/values: https://www.portfoliovisualizer.com/tes ... 0&total1=0.)

Here is my basic approach:
1. My "ideal" asset allocation in a market where prevailing valuations are close to the midpoint of the fair-value CAPE range would be 65% stocks / 35% bonds. (My age minus 5 in bonds.)
2. Above the midpoint of fair value CAPE, I would want to reduce stock allocation, but not go beyond 50 / 50.
3. Below the midpoint of fair value CAPE, I would want to increase stock allocation, but not go beyond 80 / 20.
4. Right now, I would use Vanguard's suggested fair-value CAPE range of 23-28.
5. So ... maybe something like the following. CAPE < 20: 80/20. CAPE 20-22: 75/25. CAPE 23-24: 70/30. CAPE 24-25: 65/55. CAPE 26-27: 60/40. CAPE 28-30: 55/45. CAPE > 30: 50/50.

Regarding what values of CAPE to use, I've been convinced from conversations with others on the forum that a "fair value CAPE" range is a better approach than a more simplistic CAPE. In particular, the fair value range is influenced by prevailing interest rates, and prevailing stock buyback patterns which can distort comparisons across different periods of time. In the extreme case, a fair value for CAPE in 1980 should be expected to be very different than a fair value for CAPE in 2019, because (a) interest rates were much higher then, and (b) stock buy-backs were much lower. I would like to factor these elements into my strategy.

Objective is to achieve returns consistent with 65/35 balanced portfolio, but higher sharpe ratio / lower risk. I'd like the backtesting to help me understand whether the strategy has historically achieved this. Ideally, the backtest would also adjust the fair-value CAPE range based on CPI. (Would love to also include buybacks but that sounds difficult.)

Your thoughts and/or experiences with this strategy or anything similar?
I am in the camp that valuations matter and matter a lot. I have a lot of sympathy for what you are trying to do. Still, my advice is not to do this. John Bogle's advice was that during times of extreme valuations, you might make adjustments of as much as 20% of your portfolio, it seemed like the shifts he talked about were maybe 10% to 15%. If stocks went into a mania and your normal asset allocation to stocks is 70%, you might cut back to 60%, 55% or even 50%. But this might happen once or twice during your lifetime, three at the very most. If stocks were at ridiculously low valuations, you might do the opposite, increasing your allocation to stocks by similar amounts. But again, it is rare when this happens.

A further problem is that stocks can be at a valuation extreme for longer than you thought possible, the old being right too early problem. I have done portfolio shifts three times during the 2000's but it seemed it was more about controlling risk than it was about boosting returns. Hard to say if any of that boosted my returns.

By the way, my belief is that we are not seeing valuation extremes now. We saw them on the high side in the late 1920's, the late 1960's, and the late 1990's. On the low side, we saw extremes after the 1929 crash and after the 1973-1974 bear market. Another opportunity was after the 2008-2009 bear market but stocks were probably not as cheap then as they were in 1974. These events are pretty rare.
A fool and his money are good for business.

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Re: CAPE-based asset allocation strategy?

Post by alex_686 » Tue May 14, 2019 3:04 pm

HomerJ wrote:
Sat May 11, 2019 4:34 pm
alex_686 wrote:
Sat May 11, 2019 3:22 pm
Second, my last post kind of hung of the your use of "rebalance". Every single rebalance strategy that I know of requires you to input expected market returns.
You'll have to explain that.

Rebalancing requires zero prediction of expected returns.

If I want to be 50/50, and I creep up to 55/45, I sell stocks, and buy bonds until I'm back to 50/50. There's zero looking at expected returns there. I'm just reacting to what's already happened, not what I think is going to happen.

Are you talking about CHANGING one's Asset Allocation, like the OP is suggesting? That's not rebalancing. Maybe we're misunderstanding terms.
I don't think it is about misunderstanding terms, I think it is because I rely more on theory while you rely more on heuristics. My guess.

How do you come up with your AA? Why rebalance?

Every formal method and model that I know of to generate a AA or to reblance requires you to have a estimated market return. I mean, why do you say that reblanicng does not require you to have expected market returns? If you have no opinion of the market, then why rebalance?

At the core it comes down to min/max problem where you try to minimize risk while maximizing return, and the 2 are firmly linked - you can't talk about risk without talking about returns.

Which is why I think you are kind of flying by the seat of your pants.

Now, to extend this a bit, I do think that if your opinions change on market expectations then you should update your AA. I mean, if you are basing you AA and rebalance logic on the past 100 years of returns, obviously 1 years worth of data is not going to change anything. But what if you think the past 10 years has more weight than the past 100?

And to tie this back to the OP, you have to have a opinion on market expectations to form a AA. And I like CAPE. But it is for strategic long term planning, not tactical and short term.
Glamdring56 wrote:
Sat May 11, 2019 10:36 am
I have not found an updated fair value CAPE source on the internet. Where can I find “this weeks” value of the fair market CAPE if I was so inclined?
I know that premium data sources can provide it, but why? CAPE 10 works off stale data. The last data point for most companies' earnings averages about 9 months. And CAPE 10 has a huge error margin built into its results. CAPE 10 is a cargo ship, not a speed boat. It does not handle fast turns in either earning or price well. What it does well is ignore the noise of the manic depressive market and focuses on long term trends.

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Re: CAPE-based asset allocation strategy?

Post by CFK » Tue May 14, 2019 9:01 pm

siriusblack wrote:
Thu May 09, 2019 11:16 am
Bogleheads,
I've been gravitating in my personal investing towards a CAPE-based asset allocation strategy. I'm wondering if anyone here is doing something similar, and/or if anyone here is aware of any good tools/methods for back-testing a CAPE-based asset allocation strategy?

(I've seen the Shiller PE asset allocation back-test at portfolio visualizer-- however, I don't like the #'s they used, and I don't see a good way to customize the rules/values: https://www.portfoliovisualizer.com/tes ... 0&total1=0.)

Here is my basic approach:
1. My "ideal" asset allocation in a market where prevailing valuations are close to the midpoint of the fair-value CAPE range would be 65% stocks / 35% bonds. (My age minus 5 in bonds.)
2. Above the midpoint of fair value CAPE, I would want to reduce stock allocation, but not go beyond 50 / 50.
3. Below the midpoint of fair value CAPE, I would want to increase stock allocation, but not go beyond 80 / 20.
4. Right now, I would use Vanguard's suggested fair-value CAPE range of 23-28.
5. So ... maybe something like the following. CAPE < 20: 80/20. CAPE 20-22: 75/25. CAPE 23-24: 70/30. CAPE 24-25: 65/55. CAPE 26-27: 60/40. CAPE 28-30: 55/45. CAPE > 30: 50/50.

Regarding what values of CAPE to use, I've been convinced from conversations with others on the forum that a "fair value CAPE" range is a better approach than a more simplistic CAPE. In particular, the fair value range is influenced by prevailing interest rates, and prevailing stock buyback patterns which can distort comparisons across different periods of time. In the extreme case, a fair value for CAPE in 1980 should be expected to be very different than a fair value for CAPE in 2019, because (a) interest rates were much higher then, and (b) stock buy-backs were much lower. I would like to factor these elements into my strategy.

Objective is to achieve returns consistent with 65/35 balanced portfolio, but higher sharpe ratio / lower risk. I'd like the backtesting to help me understand whether the strategy has historically achieved this. Ideally, the backtest would also adjust the fair-value CAPE range based on CPI. (Would love to also include buybacks but that sounds difficult.)

Your thoughts and/or experiences with this strategy or anything similar?
I do something similar to what OP suggests. I outlined it here: viewtopic.php?t=242047

I've tried to adjust between 85/15 and 60/40 stock to bond as valuations have changed. It also changes depending on interest rates. I've rebalanced mostly through new money.

Thus far (been doing it about two years) I don't think the results have differed much from a 75/25 portfolio. The main benefit is that I've found that if I know that I will invest more aggressively at lower valuations, it helps me think of sell-offs as buying opportunities.

I've gone back and forth about whether to just go to a static 75/25 portfolio. I'm pretty skeptical about the Shiller PE, for the reasons people have stated. That said, I intend to continue with it because I've found that being a little more conservative as valuations increase, and more aggressive during sell-offs, has helped psychologically during periods of volatility.

OP - At the end of the day, this strategy will work out fine for you because your upper and lower bounds are both reasonable. It's likely that it will perform about the same as a 65/35 portfolio.

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HomerJ
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Re: CAPE-based asset allocation strategy?

Post by HomerJ » Wed May 15, 2019 1:17 pm

CFK wrote:
Tue May 14, 2019 9:01 pm
OP - At the end of the day, this strategy will work out fine for you because your upper and lower bounds are both reasonable. It's likely that it will perform about the same as a 65/35 portfolio.
I agree with this.

And I understand that it helps some people feel better if they can DO something.

Heck, sometimes I cheat and rebalance a little early just to feel like I'm "doing something" too.

Normally I'm 50/50 and when I drift up to 55/45, I rebalance back to 50/50. But will admit I've rebalanced once or twice early at 53/47 during what felt like tumultuous times, and it felt good to "lock in those gains" (even though the market always ended up trending higher later, so I would have done better waiting for the 55/45 mark).
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Re: CAPE-based asset allocation strategy?

Post by YRT70 » Wed May 15, 2019 2:11 pm

HomerJ wrote:
Fri May 10, 2019 8:44 pm
I can't see it since it is behind a paywall.
I think this article discusses the results; https://www.kitces.com/blog/valuation-b ... lidepaths/

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HomerJ
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Re: CAPE-based asset allocation strategy?

Post by HomerJ » Wed May 15, 2019 2:31 pm

YRT70 wrote:
Wed May 15, 2019 2:11 pm
HomerJ wrote:
Fri May 10, 2019 8:44 pm
I can't see it since it is behind a paywall.
I think this article discusses the results; https://www.kitces.com/blog/valuation-b ... lidepaths/
Thanks for the link.

I completely disagree with Kitces (although I generally like his work) on this statement.
Still, the fact that most of the time a retiree doesn’t have a terrible sequence of returns at the start of retirement, and therefore usually wouldn’t need a rising equity glidepath, raises the question of whether anything can be done to predict when bad sequences are likely to occur. After all, if you knew that there was less danger of getting a decade of mediocre returns in the first place, you would be less likely to need to implement a rising equity glidepath to protect against such a bad sequence.
The risk is never zero.

Knowing that the chances of bad sequence of returns is lower is not the same as knowing they are zero.

In retirement, I would still start with the same conservative 4% withdrawal plan, and then spend more AFTER the money showed up in my account. I would not start with a 5.5% withdrawal plan because valuations predict the chance of a bad sequence is low. That's still risky, counting your chickens before they are hatched.

Sidenote: The odds are pretty high that one is going to retire into a high or "fairly-valued" valuations environment anyway, because one's money grows the fastest entering those valuations levels.

If valuations are low, the odds are you just lost some money, and are less likely to have enough to retire (unless they've been low for a long time)
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HanSolo
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Re: CAPE-based asset allocation strategy?

Post by HanSolo » Thu May 16, 2019 4:23 am

HomerJ wrote:
Wed May 15, 2019 2:31 pm
I completely disagree with Kitces (although I generally like his work) on this statement.

(snip)

The risk is never zero.

Knowing that the chances of bad sequence of returns is lower is not the same as knowing they are zero.
I don't see where Kitces says anything about "zero."

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HomerJ
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Re: CAPE-based asset allocation strategy?

Post by HomerJ » Thu May 16, 2019 9:04 am

HanSolo wrote:
Thu May 16, 2019 4:23 am
HomerJ wrote:
Wed May 15, 2019 2:31 pm
I completely disagree with Kitces (although I generally like his work) on this statement.

(snip)

The risk is never zero.

Knowing that the chances of bad sequence of returns is lower is not the same as knowing they are zero.
I don't see where Kitces says anything about "zero."
That is correct. He never says zero, therefore I'm not pulling more from my retirement plan.

Someone telling me the risk of a bad sequence of returns is LESS than normal is not reason enough to pull extra money from my retirement account at the start of my retirement.

Sure, if things turn out well, which is highly likely, I can start spending more a few years in. AFTER the money hits my bank account.

But I'm also prepared if the unlikely event happens as well.
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Re: CAPE-based asset allocation strategy?

Post by vineviz » Thu May 16, 2019 9:12 am

HomerJ wrote:
Thu May 16, 2019 9:04 am
Someone telling me the risk of a bad sequence of returns is LESS than normal is not reason enough to pull extra money from my retirement account at the start of my retirement.
It is if you understand how probability works.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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HomerJ
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Re: CAPE-based asset allocation strategy?

Post by HomerJ » Thu May 16, 2019 9:47 am

vineviz wrote:
Thu May 16, 2019 9:12 am
HomerJ wrote:
Thu May 16, 2019 9:04 am
Someone telling me the risk of a bad sequence of returns is LESS than normal is not reason enough to pull extra money from my retirement account at the start of my retirement.
It is if you understand how probability works.
You get one roll of the dice and you have one pile of money (you'll never make more). If you understand how probability works, you don't make a single out-sized bet on one roll.
Last edited by HomerJ on Thu May 16, 2019 11:39 am, edited 1 time in total.
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Re: CAPE-based asset allocation strategy?

Post by SovereignInvestor » Thu May 16, 2019 9:49 am

Yeah there is a size of bet that maximizes sharpe ratio. Even if you only get 1 bet it doesn't support not taking it..but allocating a smallet share of wealth to.it....one that maximizing Sharpe..

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Re: CAPE-based asset allocation strategy?

Post by GAAP » Thu May 16, 2019 10:59 am

I've been toying with the idea of adjusting my allocation rebalancing bands based upon CAPE -- shifting the bands so that the target is no longer in the center of the bands. I haven't had time to actually look at it -- and I'm generally leery of tactical asset allocation, so may never do so.

The idea here would be to limit the chance of over-purchasing when prices get "expensive" and similarly to limit the chances of under-purchasing when prices get "cheap". This seems to me to be more flexible than absolute CAPE values and more in line with what CAPE actually predicts (or perhaps indicates is a better word).

The degree of "accuracy" provided by CAPE is only a problem if you use it inappropriately -- and there are methods for dealing with that error.
“Adapt what is useful, reject what is useless, and add what is specifically your own.” ― Bruce Lee

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Re: CAPE-based asset allocation strategy?

Post by vineviz » Thu May 16, 2019 12:02 pm

HomerJ wrote:
Thu May 16, 2019 9:47 am
vineviz wrote:
Thu May 16, 2019 9:12 am
HomerJ wrote:
Thu May 16, 2019 9:04 am
Someone telling me the risk of a bad sequence of returns is LESS than normal is not reason enough to pull extra money from my retirement account at the start of my retirement.
It is if you understand how probability works.
You get one roll of the dice and you have one pile of money (you'll never make more). If you understand how probability works, you don't make a single out-sized bet on one roll.
If you are truly working probabilistically, you shouldn't be making a "single out-sized bet" at all.

You are, on the other hand, goin to recognize that a scenario in which there is an 0.1% probability that X will occur differs from a scenario in which there is a 99.9% chance that X will occur. Treating the two scenarios as completely identical, as you implicitly do when you approach planning with a "zero" or "not zero" mentality, is a sure-fire way to make a suboptimal decision.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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HomerJ
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Re: CAPE-based asset allocation strategy?

Post by HomerJ » Thu May 16, 2019 12:08 pm

vineviz wrote:
Thu May 16, 2019 12:02 pm
HomerJ wrote:
Thu May 16, 2019 9:47 am
vineviz wrote:
Thu May 16, 2019 9:12 am
HomerJ wrote:
Thu May 16, 2019 9:04 am
Someone telling me the risk of a bad sequence of returns is LESS than normal is not reason enough to pull extra money from my retirement account at the start of my retirement.
It is if you understand how probability works.
You get one roll of the dice and you have one pile of money (you'll never make more). If you understand how probability works, you don't make a single out-sized bet on one roll.
If you are truly working probabilistically, you shouldn't be making a "single out-sized bet" at all.

You are, on the other hand, goin to recognize that a scenario in which there is an 0.1% probability that X will occur differs from a scenario in which there is a 99.9% chance that X will occur. Treating the two scenarios as completely identical, as you implicitly do when you approach planning with a "zero" or "not zero" mentality, is a sure-fire way to make a suboptimal decision.
If the normal chance of retiring into a bad sequence of returns is 10%, and at low CAPE values, it's 2%, I'm still not going to roll the dice.

Because if the 2% chance comes up, it could hurt me financially.

And here's the thing, I will STILL get to enjoy the extra money if the more likely 98% chance comes up. I can start spending more a few years later AFTER the money hits my bank account.

That's all I'm saying. Great news that low CAPE means its likely you can spend more in retirement. It's not for sure though, so I suggest not spending the extra money BEFORE you get it based on a prediction.
The J stands for Jay

alex_686
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Re: CAPE-based asset allocation strategy?

Post by alex_686 » Thu May 16, 2019 12:42 pm

HomerJ wrote:
Thu May 16, 2019 12:08 pm
If the normal chance of retiring into a bad sequence of returns is 10%, and at low CAPE values, it's 2%, I'm still not going to roll the dice.

Because if the 2% chance comes up, it could hurt me financially.
The logical conclusion to this is a asset allocation of 100% TIPS with liability matching, which I don't think is what you are advocating.

As I alluded to earlier, risk and return are linked. If you are not 100% TIPS you are picking up risk somewhere. A 4% safe withdraw strategy is not safe - it has risks. The question in my mind is how we evaluate those risks. I think you favor more of a rule of historical thumb - which allows you to gloss over certain risks. I am on the more mathematical / theoretical side - which yes - carries risks.

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HanSolo
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Re: CAPE-based asset allocation strategy?

Post by HanSolo » Fri May 17, 2019 3:12 am

HomerJ wrote:
Thu May 16, 2019 9:04 am
That is correct. He never says zero, therefore I'm not pulling more from my retirement plan.

Someone telling me the risk of a bad sequence of returns is LESS than normal is not reason enough to pull extra money from my retirement account at the start of my retirement.
The text you quoted from Kitces (that you said you disagree with) also didn't say anything about pulling extra money from retirement. It was about whether or not one should implement a rising equity glidepath during retirement.

So the question is still open, what it was about the text you quoted that you disagree with.

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HomerJ
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Re: CAPE-based asset allocation strategy?

Post by HomerJ » Fri May 17, 2019 8:49 am

HanSolo wrote:
Fri May 17, 2019 3:12 am
HomerJ wrote:
Thu May 16, 2019 9:04 am
That is correct. He never says zero, therefore I'm not pulling more from my retirement plan.

Someone telling me the risk of a bad sequence of returns is LESS than normal is not reason enough to pull extra money from my retirement account at the start of my retirement.
The text you quoted from Kitces (that you said you disagree with) also didn't say anything about pulling extra money from retirement. It was about whether or not one should implement a rising equity glidepath during retirement.

So the question is still open, what it was about the text you quoted that you disagree with.
You are correct, I was not clear. The article shows graphs starting with larger withdrawal rates based on valuations.

The statement I quoted talked about making financial decisions differently based on certain events being less likely (but not zero).

I suggest instead that one should not pin their hopes on "less likely". If the money shows up, great. 2-3 years later you can start spending more. If the "less likely" event occurs, you are still protected.
The J stands for Jay

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