Help - My TIPS won't support a 4% SWR now

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Lbill
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Help - My TIPS won't support a 4% SWR now

Post by Lbill » Tue Nov 09, 2010 8:20 am

With the current and expected returns on stocks and bonds going lower and lower, I wondered about the withdrawal rate my TIPS ladder would now be able to support. Since TIPS provide a predictable real return, this is reasonably simple to estimate: all you need is the annual real return and your real withdrawal rate.

As Nisiprius has shown in various posts, it takes an average real return of about 1.3% to support a 4% SWR for 30 years. My rough calculation is that the average real return of a 30-year TIPS ladder is now about half that, or 0.7%. You can't make it 30 years with a real return that is half the minimum required to do so - I calculate that the TIPS ladder would fail after about 25 years with a 4% SWR. Looks like the SWR that can be supported is now closer to 3.5%. :cry: :cry:
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Post by Beagler » Tue Nov 09, 2010 9:10 am

As I've stated in the recent past, I really do wonder how adherents to Z. Bodie's investment approach are approaching this. Live on less?
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Post by Febreze » Tue Nov 09, 2010 9:13 am

Assuming you owned the TIPS ladder when the real yield was at your required return of about 2%, then on the way down to the drop of 0.7%, you experienced some capital appreciation of the bonds.

Do while you cannot withdraw 4% of the current principal, you can withdraw 4% of the principal before the yield drop.

For example, suppose you had $100k of nominal bonds at 4% yield with a duration of 10 years. Interest rates drop to 3%. Your bonds are now worth $110k.

So you can't take out 4% annually of the $110k but you can take out 4% of the initial $100k as intended.

That said I dont think TIPS are a great idea due to CPI calculation methods.

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Post by dbr » Tue Nov 09, 2010 10:08 am

Lbill, the real payout from your ladder is whatever it was when you set up the ladder. How real interest rates move after that is of no consequence unless you are running a perpetual ladder by reinvesting at lower rates.

The people that are telling you about applying that lower current yield to your now appreciated bonds are explaining the same thing from a different point of view.

It is true that someone investing today cannot get the withdrawal rate someone could have gotten starting when real rates were higher.

A related discussion involves this investor:

http://www.bogleheads.org/forum/viewtopic.php?t=62736

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Post by Lbill » Tue Nov 09, 2010 10:13 am

Assuming you owned the TIPS ladder when the real yield was at your required return of about 2%, then on the way down to the drop of 0.7%, you experienced some capital appreciation of the bonds.

Do while you cannot withdraw 4% of the current principal, you can withdraw 4% of the principal before the yield drop.
Excellent point. It is investors who are now considering buying a TIPS ladder who are affected. If they'd bought last year, their TIPS would have yielded more than the average 1.3% needed to support a 4% SWR. Now, they're going to have to look elsewhere or decrease their SWR. Not sure where else to look tho - since people like Bill Bernstein are saying that the expected real returns from stocks going forward (considering their volatility) won't be enough to support a SWR higher than 3% either.
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Post by neverknow » Tue Nov 09, 2010 10:17 am

..
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TIPS low rates

Post by bobcat2 » Tue Nov 09, 2010 10:51 am

I own TIPS bonds that mature over many years but not a complete ladder. Reinvesting the coupons is a problem but the TIPS bonds I purchased all had coupons between 2.5% and 4.25%. That is to say that the people who have been following Bodie's approach didn't learn about the approach yesterday. :)

These days the coupons get reinvested in nominal ST & IT bond funds. People who are today worrying about inflation over the next two years must be the direct descendants of the man on Noah's ark who worried incessantly for forty days and forty nights about the danger of a fire breaking out on the great ship.:lol:

BobK

PS - One of the things I like about TIPS is the calculation of inflation by the CPI tends to be biased high, not low. There are literally dozens of research papers that show this. The only disagreement is whether the bias is minor or more than minor. I suspect that it is minor. Also the CPI measure of inflation tends to track most closely the expenditure patterns of upper middle income households rather than the poor, the working near poor, middle income households, or very high income households. I like that too. :D
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Post by BlueEars » Tue Nov 09, 2010 10:54 am

Lbill wrote:...(snip)... Not sure where else to look tho - since people like Bill Bernstein are saying that the expected real returns from stocks going forward (considering their volatility) won't be enough to support a SWR higher than 3% either.
Can you provide the source for Bernstein's SWR comments? Thanks.

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Post by Tramper Al » Tue Nov 09, 2010 11:39 am

Lbill wrote:
Assuming you owned the TIPS ladder when the real yield was at your required return of about 2%, then on the way down to the drop of 0.7%, you experienced some capital appreciation of the bonds.

Do while you cannot withdraw 4% of the current principal, you can withdraw 4% of the principal before the yield drop.
Excellent point. It is investors who are now considering buying a TIPS ladder who are affected. If they'd bought last year, their TIPS would have yielded more than the average 1.3% needed to support a 4% SWR. Now, they're going to have to look elsewhere or decrease their SWR.
I guess I can see this point. My own TIPS fund proxy indicates about a 10% return YTD and I am aware of what those capital gains have done to the real yield. I'm not sure, though, that the investor who failed to set up this giant all portfolio TIPS ladder back in January would have that much regret. Pretty much everything else I track (various equity sub-classes, REITs, gold, nominal long Treasuries) is up more than TIPS over that same time period. So setting up the ladder today with these horrendous real rates, he'd actually be better off. I suppose if that ladder money was all in cash, that's a different story.
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Post by Lbill » Tue Nov 09, 2010 11:40 am

Can you provide the source for Bernstein's SWR comments? Thanks.
Here's a couple

William Bernstein wrote:
The Trinity and Bengen studies--the "4% Rule" came from the latter--were done with historical post-1926 stock returns in the US, a cherry-picked sample if there ever was one, with nominal equity returns in the 10% region.

We're now looking at forward nominal returns of around 7%: a 2% dividend yield plus 5% of nominal per-share growth: if you're a wild-eyed optimist, maybe 8%. So, in my mind, a 4% SWR goes out the window; even 3% may be a stretch.
http://www.bogleheads.org/forum/viewtopic.php?t=57393

Also relevant:
In his recent book, "Investor's Manifesto," Dr. Bernstein discusses his estimate of the future real returns of U.S. equities based on the Gordon Equation (pp. 25-35):

Expected Return = Current Dividend Yield + Dividend Growth Rate.

Based on the historical real growth of dividends in U.S. stocks, Dr. Bernstein states that the real dividend growth rate is estimated to be 1.3%. With the current dividend yield of the S&P at 1.8%, this gives us a forecast of 3.1% for the estimated real return of U.S. stocks
http://www.bogleheads.org/forum/viewtop ... highlight=
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Post by bob90245 » Tue Nov 09, 2010 12:13 pm

Tramper Al wrote:My own TIPS fund proxy indicates about a 10% return YTD and I am aware of what those capital gains have done to the real yield. I'm not sure, though, that the investor who failed to set up this giant all portfolio TIPS ladder back in January would have that much regret. Pretty much everything else I track (various equity sub-classes, REITs, gold, nominal long Treasuries) is up more than TIPS over that same time period. So setting up the ladder today with these horrendous real rates, he'd actually be better off. I suppose if that ladder money was all in cash, that's a different story.
From an accumulation stand point, yes. But not if converting this nest egg today using today's lower yield on TIPS for distribution going forward for retirement income.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: Help - My TIPS won't support a 4% SWR now

Post by Doc » Tue Nov 09, 2010 12:27 pm

Lbill wrote:With the current and expected returns on stocks and bonds going lower and lower, I wondered about the withdrawal rate my TIPS ladder would now be able to support. Since TIPS provide a predictable real return, this is reasonably simple to estimate: all you need is the annual real return and your real withdrawal rate.
...

:cry: :cry:
While you may be correct in your reasoning one should ask "what does it have to do with TIPS?" You nailed the problem in your opening sentence, "... (the) expected returns on stocks and bonds going lower and lower ..."

OK, returns in general are lower, what do you do? Save more, lower your goal or take on more risk? Your TIPS ladder was an essentially risk free approach to an SWR. So since you don't want to increase the risk you need to either save more or lower your goal. Problem solved.

(I don't like the situation either since we are already retired and neither my wife or I enjoy dog food. :cry: I am replacing maturing TIPS with short term investment grade corporates as a holding action only.)
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Post by Tramper Al » Tue Nov 09, 2010 12:32 pm

bob90245 wrote:
Tramper Al wrote:My own TIPS fund proxy indicates about a 10% return YTD and I am aware of what those capital gains have done to the real yield. I'm not sure, though, that the investor who failed to set up this giant all portfolio TIPS ladder back in January would have that much regret. Pretty much everything else I track (various equity sub-classes, REITs, gold, nominal long Treasuries) is up more than TIPS over that same time period. So setting up the ladder today with these horrendous real rates, he'd actually be better off. I suppose if that ladder money was all in cash, that's a different story.
From an accumulation stand point, yes. But not if converting this nest egg today using today's lower yield on TIPS for distribution going forward for retirement income.
My point has nothing to do with accumulation or distribution, bold or otherwise. The OP I think is suggesting that buying your TIPS now vs. a few months ago with an average real rate of 1.3% is fundamentally night and day doomed to fail different. I suggest that unless your "nest egg" nominal performance has been less than that of the hypothetical TIPS ladder during this same interval, then you are in the same or better position (to buy that ladder) today. And looking back over the various (post 3/09?) time frames that I think we are talking about, I find very few common asset classes that have lost substantial ground to TIPS. That's all.

You do realize I'm sure that the TIPS ladder bought back in the good old days of 1.3% average has today the same real yield to maturity as the same ladder rungs bought today? The only difference is again the interim return.

So yes I agree that the identical TIPS ladder is more expensive today than it was a few months ago. But unless your ladder budget has been in tulips or cash, it should have increased just as much or more.

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Post by bob90245 » Tue Nov 09, 2010 1:55 pm

Tramper Al wrote:So yes I agree that the identical TIPS ladder is more expensive today than it was a few months ago. But unless your ladder budget has been in tulips or cash, it should have increased just as much or more.
We seem to be talking past each other. While both statements above are true, the latter is beside point. Let me illustrate an example.

Let's say a few months ago, I had $900,000 with the goal of growing the portfolio to $1,000,000. My expectation was to converting it to a TIPS ladder with yields of 1.3% in order to generate CPI-adjusted annual income of $40,000. Well, thanks to the recent rally, my portfolio is now at $1,000,000. But I can no longer obtain 1.3% TIPS to generate the $40,000 income I am seeking.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Post by Tramper Al » Tue Nov 09, 2010 2:22 pm

bob90245 wrote:
Tramper Al wrote:So yes I agree that the identical TIPS ladder is more expensive today than it was a few months ago. But unless your ladder budget has been in tulips or cash, it should have increased just as much or more.
We seem to be talking past each other. While both statements above are true, the latter is beside point. Let me illustrate an example.

Let's say a few months ago, I had $900,000 with the goal of growing the portfolio to $1,000,000. My expectation was to converting it to a TIPS ladder with yields of 1.3% in order to generate CPI-adjusted annual income of $40,000. Well, thanks to the recent rally, my portfolio is now at $1,000,000. But I can no longer obtain 1.3% TIPS to generate the $40,000 income I am seeking.
Sure, I understand that sort of example. You were short of the funds necessary for that ideal TIPS ladder by $100K then and you are probably short by about $100K now as well, if the cost of your ladder has also increased by about 11%, to $1,111,000 or so. That's pretty much all that has happened. Naturally, if instead you were invested in something that did not increase in value in the interim, then obviously you are in fact further from your goal. Cash/MMF being a good example.

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Re: TIPS low rates

Post by Beagler » Wed Nov 10, 2010 6:38 pm

bobcat2 wrote: ...One of the things I like about TIPS is the calculation of inflation by the CPI tends to be biased high, not low. There are literally dozens of research papers that show this. The only disagreement is whether the bias is minor or more than minor. I suspect that it is minor. Also the CPI measure of inflation tends to track most closely the expenditure patterns of upper middle income households rather than the poor, the working near poor, middle income households, or very high income households. I like that too.
Are Dr. Bernstein and Jack Bogle misinterpreting the data you're reading?

From BH9 transcript http://tinyurl.com/22su7jl
Image

Everyone, of course, experiences their own set of inflation factors. For a retiree, does this look like your household expenses?
Image
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Post by bobcat2 » Wed Nov 10, 2010 9:26 pm

The CPI basket of goods and services tends to vary at least as much by income level as by age. The basket most closely tracks high middle income consumers. Both Bill Gates and families on welfare tend to have consumption patterns not nearly as close. The poor spend lots of their income on essentials like food and energy; Bill not so much. OTOH it takes a lot of poor households to have the same weight in the overall CPI basket as Paris Hilton or Lebron James. It is this last aspect that makes the CPI track best upper middle income households, rather than median or even mean households.

So when the volatile food and energy components of the CPI are high, poor people have higher inflation than the CPI and Mr. Gates lower inflation than the index. When the volatile food and energy components of the CPI are low, poor people have lower inflation than the CPI and Mr. Gates higher inflation than the index. As you may have guessed this tends to mostly cancel out over long time periods, but over individual years it makes a difference and means that low income and very high income households have significantly higher tracking errors from year to year than high middle income households.

BobK

PS - The graph looks roughly right to me. It has to be off by a lot on something far removed from most price movements to make a big difference. Two components than tend to rise faster than general prices are college costs and medical care. The elderly, as a group, have more of the latter than the general population but essentially none of the former. So these high inflation items are somewhat offsetting when talking about the elderly, not completely but somewhat. What can vary a lot is how healthy you are and how good your health insurance is. The relatively healthy elderly with Medicare spend a lot less on health care than the relatively unhealthy working age with crummy or nonexistent health insurance. The housing component share depends on whether you rent, own but are paying on the mortgage, or own mortgage free.
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Post by savermike » Wed Nov 10, 2010 11:56 pm

bobcat2 wrote:The CPI basket of goods and services tends to vary at least as much by income level as by age. The basket most closely tracks high middle income consumers. Both Bill Gates and families on welfare tend to have consumption patterns not nearly as close. The poor spend lots of their income on essentials like food and energy; Bill not so much. OTOH it takes a lot of poor households to have the same weight in the overall CPI basket as Paris Hilton or Lebron James. It is this last aspect that makes the CPI track best upper middle income households, rather than median or even mean households.
Got a quality cite for further reading along these lines? CPI nailing neither median nor average consumers sounds funny.

Mike

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Post by LH » Thu Nov 11, 2010 1:47 am

Lbill wrote:
Assuming you owned the TIPS ladder when the real yield was at your required return of about 2%, then on the way down to the drop of 0.7%, you experienced some capital appreciation of the bonds.

Do while you cannot withdraw 4% of the current principal, you can withdraw 4% of the principal before the yield drop.
Excellent point. It is investors who are now considering buying a TIPS ladder who are affected. If they'd bought last year, their TIPS would have yielded more than the average 1.3% needed to support a 4% SWR. Now, they're going to have to look elsewhere or decrease their SWR. Not sure where else to look tho - since people like Bill Bernstein are saying that the expected real returns from stocks going forward (considering their volatility) won't be enough to support a SWR higher than 3% either.
1979 the death of equites.

2010 the sickness of equites.

Recency anyone?

break out the crystal ball, and the 1959 gordon equation, both with just wonderful predictive ability for pertinent 30 year timeperiods.

"riskless" TIPS ladders are mythical beasts, its funny it showed up this clearly, this soon though.
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Post by GammaPoint » Thu Nov 11, 2010 1:52 am

LH wrote:
1979 the death of equites.
What did the Gordon equation predict in 1979?

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Post by LH » Thu Nov 11, 2010 2:09 am

GammaPoint wrote:
LH wrote:
1979 the death of equites.
What did the Gordon equation predict in 1979?
What does the gordon equation ever meaningfully predict for an investor, in 1979, 2007, or 2010? You got me. It was created in 1959, and is now somehow useful again in forward prognostication.

1979 is a reference to the famous business week "death of equites" prognostication. Which of course, had very sound reasoning behind it, inflation, etc. etc. and was also followed by quite the opposite.

Point is, we cannot predict jack.

All this talk, even here on the boglehead board, is mostly just recency bias noise. Maybe I have missed it, but the 1959 Gordon Equation, that is being used to predict below par returns, simply does not have ability to predict much at all in ones investing lifetime, say 30 years. The reason this occurs, and is given a pass now, is recency bias. Bad times recently, means anything, no matter how weak like the gordon equation, will be given more weight to "confirm" what our guts are telling us.

If the Gordon equation was so great, it should have been able to be used in 2007, and people should have paid attention to it then. Fact is, it just does not have any more predictive ability now, than it did in 2007....... People ignored it in 2000-2007 effectively, but now, oh, yeah stocks are gonna do poorly. That is just recency, recency, recency.

This "sickness of equites" talk, is akin to the "death of equites" talk. Simple recency, and recycling of 1959 equations.

LH

PS yes, some, Bogle included, have been talking about low returns for a while, 10 years or more, thats fine, and certainly not recency. But that does not mean Gordon equation is meaningfully predictive.

http://www.businessweek.com/investor/co ... 263462.htm

So if you are back in 1979 ever, make sure you do NOT invest in stocks in the 1980s, as equites are dead, and will not return. Read the accompanying article sometime, pretty convincing stuff. Its GREAT we are here though, 2010, and can have predictions going forward of sickly, anemic stock returns, based on the 1959 Gordon equation, and maybe inflation, deflation, or whatever else the prognosticators pull up. So yeah, this time is different, stocks are NOT dead, just sick.

Its not simple recency bias influencing prognostications, no way. We humans are much better than that nowadays.

Anyway, 100 TIPS ladders. one needs diversification. There is reinvestment risk, creation risk, cpi-u manipulation risk, etc with 100 percent TIPS, its not riskless. One is expected to have less money, compared with having some stocks. Oh! But one can KNOW just how much one needs, and ignoring all the above, since TIPS ladders are riskless, perfectly match need with the tips ladder.... What more is needed?

Well, for one, the ability to know ones needs going forward..... You may well need more money than you think you do, and that is another risk of 100 percent TIPS...... You did a nice match, did all the maths, knew your needs, gave a safety margin, and then BOOM, life happens, and you need more money. Money you could have actually had expectantly, had you included some "risky" stock in there.

its always better to have more money. The whole thing about, having "excess" money, and taking on too much risk to get that "excess" money, is only one side of the coin...... The other side is, you may actually in hard core reality, NEED that "excess" money......

That is a big risk. The "excess" money risk, not actually being "excess"

Life is not a theoretical 100 percent ladder, and the more money one can have at reasonable risk, the better. The whole 100 percent "riskless" TIPS thing, badly conflates theory with reality. One cannot expect to create a TIPS ladder, maintain a TIPS ladder, predict how much money one needs for the TIPS ladder due to future needs being unknown.

There is no way to fix the problem besides diversification. A TIPS ladder cannot be expected to be riskless, and one is missing out on significant diversification and expected gain by ignoring stocks.

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Post by neverknow » Thu Nov 11, 2010 6:58 am

..
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Post by wearethefall » Thu Nov 11, 2010 7:15 am

LH wrote:
GammaPoint wrote:
LH wrote:
1979 the death of equites.
What did the Gordon equation predict in 1979?
What does the gordon equation ever meaningfully predict for an investor, in 1979, 2007, or 2010? You got me. It was created in 1959, and is now somehow useful again in forward prognostication.

1979 is a reference to the famous business week "death of equites" prognostication. Which of course, had very sound reasoning behind it, inflation, etc. etc. and was also followed by quite the opposite.

Point is, we cannot predict jack.

All this talk, even here on the boglehead board, is mostly just recency bias noise. Maybe I have missed it, but the 1959 Gordon Equation, that is being used to predict below par returns, simply does not have ability to predict much at all in ones investing lifetime, say 30 years. The reason this occurs, and is given a pass now, is recency bias. Bad times recently, means anything, no matter how weak like the gordon equation, will be given more weight to "confirm" what our guts are telling us.

If the Gordon equation was so great, it should have been able to be used in 2007, and people should have paid attention to it then. Fact is, it just does not have any more predictive ability now, than it did in 2007....... People ignored it in 2000-2007 effectively, but now, oh, yeah stocks are gonna do poorly. That is just recency, recency, recency.

This "sickness of equites" talk, is akin to the "death of equites" talk. Simple recency, and recycling of 1959 equations.

LH

PS yes, some, Bogle included, have been talking about low returns for a while, 10 years or more, thats fine, and certainly not recency. But that does not mean Gordon equation is meaningfully predictive.

http://www.businessweek.com/investor/co ... 263462.htm

So if you are back in 1979 ever, make sure you do NOT invest in stocks in the 1980s, as equites are dead, and will not return. Read the accompanying article sometime, pretty convincing stuff. Its GREAT we are here though, 2010, and can have predictions going forward of sickly, anemic stock returns, based on the 1959 Gordon equation, and maybe inflation, deflation, or whatever else the prognosticators pull up. So yeah, this time is different, stocks are NOT dead, just sick.

Its not simple recency bias influencing prognostications, no way. We humans are much better than that nowadays.

Anyway, 100 TIPS ladders. one needs diversification. There is reinvestment risk, creation risk, cpi-u manipulation risk, etc with 100 percent TIPS, its not riskless. One is expected to have less money, compared with having some stocks. Oh! But one can KNOW just how much one needs, and ignoring all the above, since TIPS ladders are riskless, perfectly match need with the tips ladder.... What more is needed?

Well, for one, the ability to know ones needs going forward..... You may well need more money than you think you do, and that is another risk of 100 percent TIPS...... You did a nice match, did all the maths, knew your needs, gave a safety margin, and then BOOM, life happens, and you need more money. Money you could have actually had expectantly, had you included some "risky" stock in there.

its always better to have more money. The whole thing about, having "excess" money, and taking on too much risk to get that "excess" money, is only one side of the coin...... The other side is, you may actually in hard core reality, NEED that "excess" money......

That is a big risk. The "excess" money risk, not actually being "excess"

Life is not a theoretical 100 percent ladder, and the more money one can have at reasonable risk, the better. The whole 100 percent "riskless" TIPS thing, badly conflates theory with reality. One cannot expect to create a TIPS ladder, maintain a TIPS ladder, predict how much money one needs for the TIPS ladder due to future needs being unknown.

There is no way to fix the problem besides diversification. A TIPS ladder cannot be expected to be riskless, and one is missing out on significant diversification and expected gain by ignoring stocks.
The Gordon equation is:

expected return from stocks = dividend yield + dividend growth rate


The dividend growth rate is approximately equal over time, so the equation predicts that expected returns are chiefly driven by changing dividend yields.

The dividend yield was high in 1979 ... and we observed high returns
The dividend yield was low in 2000 ... and we observed low returns
The dividend yield was low in 2007 ... and we observed low returns

Seems like the 1959 equation did pretty well to me. IMO the problem is with investors.

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The myth of the riskless investment

Post by bobcat2 » Thu Nov 11, 2010 9:04 am

There are no riskless investment assets. So lets do away with this straw man argument. But there is a continuum of risk that investment assets have. The safest investment asset depends on the strategy. If I want assets to purchase a boat in six months the safest asset is six month Tbills. If I want to pay off the remaining balance of my mortgage in five years the safest asset is a five year zero coupon nominal Treasury bond. If I want a certain level of inflation-indexed income as safely as possible to sustain some given level of real consumption in ten years then the safest assets are TIPS, Ibonds, and inflation indexed annuities. If I want to leave my daughter a minimum bequest the safest asset is whole life insurance in that amount.

Insurance and fixed income assets held to maturity are the safest because they have known terminal values. So if you want to have as safely as possible a given amount of an asset value in the future to match a targeted liability you must use fixed income or insurance. Diversification thru equities will give you a higher expected value, a chance at a very high return, but also a chance at a very low return, far below your target. Any Japanese stock investor over the last 20 years can tell about the last part. You have to decide how much of your assets to meet future financial goals you want to be relatively safe and how much to be relatively risky. This is a personal preference for which there is no general answer.

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

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The plutocratic gap

Post by bobcat2 » Thu Nov 11, 2010 9:24 am

Got a quality cite for further reading along these lines? CPI nailing neither median nor average consumers sounds funny.
The gap between the CPI weighted by expenditures (so that higher income households will naturally get a greater weight) and the CPI weighted by the average over households, irrespective of each household's total expenditures, is sometimes termed the "plutocratic gap".
Another way of tackling this question is to ask what kind of household has a consumption pattern that matches the CPI? The answer is as follows:

It is natural to ask then what is the household better represented by the plutocratic CPI. Muellbauer (1974) searched for the household whose budget shares were closest to the ... aggregate weights in the UK CPI, and found it to be at the 71st percentile in the household expenditures distribution. For the US in 1990, Deaton (1998) estimates that this consumer occupies the 75th percentile. Thus, the 'representative' consumer embedded ... is inclined towards upper-expenditure households.
In other words the CPI tends to track Bogleheads well. :D

http://www.econbrowser.com/archives/200 ... of_pe.html

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Re: The myth of the riskless investment

Post by bob90245 » Thu Nov 11, 2010 11:16 am

bobcat2 wrote:Diversification thru equities will give you a higher expected value, a chance at a very high return, but also a chance at a very low return, far below your target. Any Japanese stock investor over the last 20 years can tell about the last part.
You had a strong argument until the last part. I don't know any Japanese investors. But don't they have the ability to invest in a widely diversified global equity portfolio like we do here in the US?
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Post by TrustNoOne » Thu Nov 11, 2010 11:40 am

If the OP has held a TIPs ladder then the value has most certainly appreciated a lot. My review shows that inflation indexed annuities can provide something pretty close to 4% if one is around 60. Might be a good time to sell the TIPs and buy the annuity. (Depending on age, circumstances, etc.)

In any case, I don't think a true TIPs ladder really exists - there are too many holes in the TIPs available. So one can't ladder them and faces the market risk of having to sell some of the TIPs prior to maturity.

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Post by bobcat2 » Thu Nov 11, 2010 11:51 am

I don't know if it was that easy for Japanese investors to invest in foreign stocks through most of the 1990s. But in any event Japanese investors would probably put most of their stock investments in domestic Japanese stocks, much like American investors. For one thing the Japanese stock market was the biggest in the world in the late 80s and early 90s. For another, like investors everywhere, they would take into account the currency risk that holding foreign stocks entails, but domestic stock holdings avoid. And don't forget that over the last 11 years the foreign stock holdings of Japanese investors would have had about zero real returns. So a Japanese stock investor that was 70/30 domestic/foreign stocks would have posted significantly negative real equity returns over the last 20 years.

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Post by bob90245 » Thu Nov 11, 2010 12:33 pm

bobcat2 wrote:I don't know if it was that easy for Japanese investors to invest in foreign stocks through most of the 1990s. But in any event Japanese investors would probably put most of their stock investments in domestic Japanese stocks, much like American investors. For one thing the Japanese stock market was the biggest in the world in the late 80s and early 90s. For another, like investors everywhere, they would take into account the currency risk that holding foreign stocks entails, but domestic stock holdings avoid. And don't forget that over the last 11 years the foreign stock holdings of Japanese investors would have had about zero real returns. So a Japanese stock investor that was 70/30 domestic/foreign stocks would have posted significantly negative real equity returns over the last 20 years.

BobK
I'm glad I'm not a Japanese investor. I thank my lucky stars my balanced portfolio has delivered generous returns even factoring two bear markets this past decade.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: The myth of the riskless investment

Post by LH » Thu Nov 11, 2010 12:54 pm

bobcat2 wrote:There are no riskless investment assets. So lets do away with this straw man argument. But there is a continuum of risk that investment assets have. The safest investment asset depends on the strategy. If I want assets to purchase a boat in six months the safest asset is six month Tbills. If I want to pay off the remaining balance of my mortgage in five years the safest asset is a five year zero coupon nominal Treasury bond. If I want a certain level of inflation-indexed income as safely as possible to sustain some given level of real consumption in ten years then the safest assets are TIPS, Ibonds, and inflation indexed annuities. If I want to leave my daughter a minimum bequest the safest asset is whole life insurance in that amount.

Insurance and fixed income assets held to maturity are the safest because they have known terminal values. So if you want to have as safely as possible a given amount of an asset value in the future to match a targeted liability you must use fixed income or insurance. Diversification thru equities will give you a higher expected value, a chance at a very high return, but also a chance at a very low return, far below your target. Any Japanese stock investor over the last 20 years can tell about the last part. You have to decide how much of your assets to meet future financial goals you want to be relatively safe and how much to be relatively risky. This is a personal preference for which there is no general answer.

BobK
Well, you say straw man, and I cannot recollect your past posts offhand, but I think you would agree, at minimum, that there has been conflation between the "risk free" TIPS, and actually being -risk free- on the part of some????? I do not think that is a "straw man" at all. This is a real misconception of some. You may personally be talking past some on this issue, but the use of the term "risk free" is very easily conflated with -risk free- imagine that. And reading some of this 100 percent TIPS stuff, the conflation appears to be through and through the issue.

I have read these 100 percent TIPS posts, "risk free" bantered about, and these theoretical 100 percent TIPS ladders, how that is less risky per se, than basically anything else, congruent matching of 1)future need over years and 2)predictable return over years via 100 percent TIPS ladders. Quite the trick that. One avoids that nasty "excess money" risk then right? Riight. Then there is the unfortunate problem of 1)making the ladder to begin with with a reasonable SWR expectantly 2)maintaining the ladder with reinvestment risk........

Here is another step below that then:

100 percent TIPS if not "risk free" is almost by definition, "less risky" than say 10 percent stock, 90 percent TIPS.........

You agree with that? 100 percent TIPS, is in ---real world---- ---less risky--- than 90 TIPS, 10 percent stock???? Where risk is defined as not having enough money to meet ones needs going forward?

To me, given the choice between

1) 100 percent TIPS ladder
2) 90 TIPS and 10 TSM

Number two, is real world less risky I posit. One is more likely to have the money one needs with number 2, than number 1 expectantly. What say you?

thanks for your consideration,

LH

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Post by snowman9000 » Thu Nov 11, 2010 5:54 pm

I find it shocking to see the term risk-free used AT ALL.

IF, say, there is an X% chance that the dollar will become worthless or nearly so in a black swan event sometime in the next hundred years, THEN there is a measurable chance that it will happen in the next ten years.

IF, say, there is an X% chance that the FDIC will default on deposit insurance... etc.

IF there is an X% chance that the US government will default on its debts... etc.

And, such event does not have to include end of the world scenarios in which the dollar/account/bond holder presumably has more pressing concerns involving toilet paper. It could mostly involve the collapse of the dollar or the domestic economy, while those with other investments retain some or all of their wealth. This exact thing has happened in other countries in recent memory. Yet not only do we not view it as the white swan it is, we don't even view it as a black one. The reason we don't is because for the most part we have no idea how to deal with the risk. So we don't acknowledge it. Instead we lump it into the category of "things mostly beyond our control". But that doesn't mean the risk doesn't exist.

To my way of thinking, NO investment is risk-free.

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Post by bobcat2 » Thu Nov 11, 2010 5:55 pm

Hi LH,

I would say the risk attributes of the portfolio depend on what strategy you are using to manage risk. If you are managing risk thru diversification then I see little difference in risk between 100% TIPS and 90/10 TIPS/equities. If you are using TIPS ladders or something close to a TIPS ladder as a matching strategy of future income for consumption then the all TIPS portfolio is safer. What the 90/10 portfolio in that case provides is upside potential, but a lower safe floor compared to the all TIPS portfolio. The question with very high TIPS bonds allocation as a matching strategy isn't, is it safe? Instead it is, is it enough? :lol:
Just because the safest strategy isn't enough to meet your goal doesn't mean it isn't the safest strategy. It just means that you will have to take more risk than the safest strategy entails to meet your goals. (You will have some chance of falling much farther from meeting your goals than if you use the safe strategy.)

There is no safe financial asset for all situations. Holding Tbills for extended periods of years is not particularly safe. Holding TIPS when the liability is nominal is not nearly as safe as holding zero coupon nominal Treasuries. Holding nominal Treasury bonds isn't as safe as TIPS when the liability is real rather than nominal. The terminology "risk-free" asset is an unfortunate use of words at best. What we really have for different situations are low risk to high risk assets. And the lowest risk assets are different in different situations.

BobK
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Post by Beagler » Thu Nov 11, 2010 6:29 pm

bobcat2 wrote:The question with very high TIPS bonds allocation as a matching strategy isn't, is it safe? Instead it is, is it enough? :lol:
Imagine the young accumulator starting today along a TIPS-centric investment path.
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Post by bobcat2 » Thu Nov 11, 2010 7:27 pm

Hi Beagler,

A 29 year old wants to save and invest $10,000 this year in her 401k. She can invest in individual TIPS bonds within her 401k and given the uncertain current economic and financial conditions she wants to invest $3,000 of the $10,000 safely. Also she is concerned about the possibility of high inflation over the next 30 years. What is wrong in your opinion with her purchasing three 30 year TIPS bonds with the safe money? Currently 30 year TIPS are yielding 1.58% real.

BobK
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Post by Beagler » Thu Nov 11, 2010 7:50 pm

bobcat2 wrote:Hi Beagler,

A 29 year old wants to save and invest $10,000 this year in her 401k. She can invest in individual TIPS bonds within her 401k and given the uncertain current economic and financial conditions she wants to invest $3,000 of the $10,000 safely. Also she is concerned about the possibility of high inflation over the next 30 years. What is wrong in your opinion with her purchasing three 30 year TIPS bonds with the safe money? Currently 30 year TIPS are yielding 1.58% real.

BobK
Hi Bob,
Is her goal to build a ladder of TIPS, or just to pick the highest-yielding bonds throughout her investing career, no matter the duration? Remember, my question is about a TIPS-centric (Bodie-esque) portfolio.
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Post by alec » Thu Nov 11, 2010 8:10 pm

Beagler wrote:
bobcat2 wrote:Hi Beagler,

A 29 year old wants to save and invest $10,000 this year in her 401k. She can invest in individual TIPS bonds within her 401k and given the uncertain current economic and financial conditions she wants to invest $3,000 of the $10,000 safely. Also she is concerned about the possibility of high inflation over the next 30 years. What is wrong in your opinion with her purchasing three 30 year TIPS bonds with the safe money? Currently 30 year TIPS are yielding 1.58% real.

BobK
Hi Bob,
Is her goal to build a ladder of TIPS, or just to pick the highest-yielding bonds throughout her investing career, no matter the duration? Remember, my question is about a TIPS-centric (Bodie-esque) portfolio.
As a 30 something putting Bodie's ideas to use, perhaps I can answer. My goal is to, at retirement, purchase inflation adjusted SPIAs to cover the retirement income that SS and my pension don't. I want to "fund" [read: save for] that SPIA with ind TIPS. Ideally I want to buy 30 year TIPS now b/c I want the most certain way of having a certain amount of $$ in 30 years. This can also be read as "I want the most certain way of moving $$ [i.e. deferring consumption] from today to 30 years from now."

Unfortunately, retirement account choices limit my use of individual LT TIPS [of which I have some], so I have to use stable value funds too. Not perfect, but I'm a satisficer. 8)
"It is difficult to get a man to understand something, when his salary depends upon his not understanding it!" - Upton Sinclair

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Post by bobcat2 » Thu Nov 11, 2010 8:51 pm

Hi Beagler,

If a 29 year old plans to retire some time after age 60, why would she want to be buying individual TIPS bonds now that mature well before her targeted retirement date in her 401k retirement fund? That never even occurred to me. I don't understand why she would consider doing that. After all it's a retirement account.

BobK
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Post by LH » Fri Nov 12, 2010 12:56 am

bobcat2 wrote:Hi LH,

I would say the risk attributes of the portfolio depend on what strategy you are using to manage risk. If you are managing risk thru diversification then I see little difference in risk between 100% TIPS and 90/10 TIPS/equities. If you are using TIPS ladders or something close to a TIPS ladder as a matching strategy of future income for consumption then the all TIPS portfolio is safer. What the 90/10 portfolio in that case provides is upside potential, but a lower safe floor compared to the all TIPS portfolio. The question with very high TIPS bonds allocation as a matching strategy isn't, is it safe? Instead it is, is it enough? :lol:
Just because the safest strategy isn't enough to meet your goal doesn't mean it isn't the safest strategy. It just means that you will have to take more risk than the safest strategy entails to meet your goals. (You will have some chance of falling much farther from meeting your goals than if you use the safe strategy.)

There is no safe financial asset for all situations. Holding Tbills for extended periods of years is not particularly safe. Holding TIPS when the liability is nominal is not nearly as safe as holding zero coupon nominal Treasuries. Holding nominal Treasury bonds isn't as safe as TIPS when the liability is real rather than nominal. The terminology "risk-free" asset is an unfortunate use of words at best. What we really have for different situations are low risk to high risk assets. And the lowest risk assets are different in different situations.

BobK
"Just because the safest strategy isn't enough to meet your goal doesn't mean it isn't the safest strategy. It just means that you will have to take more risk than the safest strategy entails to meet your goals."

I dunno. You are switching terminology, from an already vague terminology of "risk", which I at least defined in the question for purposes of discussion, to the word "safest" which is vague. (edit: maybe its not, see end, and sorry for the length and wordiness, but thinking my way through this semantics)

But in regards to the above. Anyones "safest" strategy then.... Would be 100 percent TIPS right???? By definition, thats the "safest". That really appears to be what you are saying. I mean, to be "safest", one should never be in stocks, and always be 100 percent tips..... That is basically the so called "straw man" I am talking about, is it not?????? One little segue from "safest" to "lowest risk" or even the proverbial "risk free" is all it takes, and boom, there is the so called straw man, real life....... right??????
If you are managing risk thru diversification then I see little difference in risk between 100% TIPS and 90/10 TIPS/equities. If you are using TIPS ladders or something close to a TIPS ladder as a matching strategy of future income for consumption then the all TIPS portfolio is safer.
That seems to beg the question, by refering to different states of "managing the risk"......... Especially, parse that second sentence, its almost circular, if using tips ladder, tips ladder is safer???

I mean, look, its a general person, two states:

1)100 TIPS ladder
2)same tips ladder, but with 10 percent TSM

you are saying that how one "feels" about the two states, impinges upon the relative risks of the two states? That if one is "managing the risk" one way, or another, in ones mind, that somehow that hits upon risk??? I would think not. But what exactly are you saying then? Because at one point, you say that they are NOT different, then you say they are different, and the tips is safer..... Perhaps you are talking about some sort of mechanism difference between the states?
---------------
Stipulate:

Risk is the chance of not having enough money for ones actual needs, real life, in the uncertain actual future we will face.
---------------
Otherwise, we can babble back and forth and talk past each other, "risk" "Safe" have to be stipulated right? I mean here, you even switch from "safe" to "enough" which seems to be akin to my stipulated def of risk, enough/not enough, but I am unclear... (edit, see end, I think I may understand what you mean by "safe" but.... hmmmm..)
The question with very high TIPS bonds allocation as a matching strategy isn't, is it safe? Instead it is, is it enough?
Also, a TIPS ladder is not guaranteed to make its payments. Its a real world thing, if you say, ah well the tips ladder failed, you just didnt calculate it right.... Well whoa..... slow down there. This is pedal to the medal, real world. This is not LTCM gobbleygook, Ignore the Dragon risk. Tips can fail to meet needs. It has risk. You have to be able to put the plan into action, in reality. It has to meet your needs in reality. You cannot spend theory in the end. 100 percent TIPS ladders as a practical application seem mythological for the average person in terms of ability to meet real needs.

I mean, one could say, hey, LTCM did not fail, they just did the equation wrong!!! Well....... they did fail. In reality, if TIPS do not meet ones needs, they fail, "safest" or not.

The other point is, just to specifically address that diversification distinction you were making that I do not follow. Consider that its just a gradient, efficient frontier or whatever, from ZERO diversification, to 50/50, to zero diversification on the other side. 100 bonds 90/10, 50/50, 10/90, to 100 stocks.... Its like talking efficient frontier, and saying hey, the end dots of 100 percent do not belong on the chart! Its begging the question? Is it not? I mean, you are saying 100 percent TIPS can stand alone in isolation from 90/10 tips/tsm????? Because of how one.... what, manages it? I just do not follow.

Insurance, to get back to your original post, has risk to it, of the uncertain kind. I mean, heck, all the people in Greece, are guaranteed by a state, to retire at 55 with nice benefits right? Right. Yeah.... Except for some slight problem of nowhere near enough actual money, its gonna work out fine for the greeks, it guaranteed. So, give your money to an insurance company, you are guaranteed payment for 30 years+..... right. No risk. Or not even worth mentioning the risk. Same thing with Social Security, heck, benefits are guaranteed, or wait, maybe its only 76 percent of what they promise, glancing at a recent statement.... Hmmmm. Well geesh, so the biggest financial entity in the world, US, is saying it is gonna fail at its annuity payments (SS), but hey, a private insurance company, is gonna swing it, lets not even mention the risk of failure of that....... Not even discuss it????? Hey, its backed by the government though! Unfortunately, the same government that cant swing social security as promised......

To me, there seems to be this theory of "excess" money, mythical matching of consumption to future needs ignoring the risk of wrong matching, and the actual need for the "excess" money. I think the papers on the subject, just stipulate all that away, but in reality, it is still there. Its basically the LTCM dragon risk, but in reality, dragons are friggin everywhere.

To tell someone that 100 percent TIPS is the "safer" investment, and seque into some sort of "risk" discussion, especially mentioning "risk free" is a disservice (talking about prior discussions, not you per se here).

Your definitional "safest investment" may have the greater expectation of one not having enough money to meet one needs, which include good health care, so yeah, tips are "safe" but may result in worse expectant health care and expectant earlier death, but have a lower "floor" of loss...... Thats "safer"......

I mean, could I not, by your definition of "safe" construct a TIPS ladder, that is guaranteed to not provide my needs, guarantee failure expectantly, guarantee bankruptcy, but since its TIPS, that is still the "safest"!!!???????????? Is that right?

"safe" its merely just not losing money via strategy????

The whole thing, just does not seem practically orientated to the real world, but people are reading all this stuff, and thinking, hmmmm, 100percent tips ladders are "safe" "safest" (or the unfortunate "risk free"), I should invest my money that way..... When the "safe" course of action can be expectant bankruptcy, just a low floor of strategy loss, not enough money, but hey, thats ok??????

Man, I just see more and more "straw men". Definitional TIPS "safest" where safety can mean you cant pay for food, but you are "safe", its the "safest" approach, and other approaches, less likely to fail, involve "more risk" by definition????

That form of "safest" cant be -safe-, just like "risk free" is not -risk free-.

thanks for your consideration,

LH

PS I mean, I think I am actually starting to follow what you are saying, but geesh.... talk about talking past one another.

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Post by Dick Purcell » Sat Nov 13, 2010 11:25 am

This whole discussion is superb.

Does this forum ("Theory etc. . . ") have a way to list discussions by reader vote of value, instead of (I mean in addition to) the listing by most-recent? If not, could such a separate listing be developed?

For that new listing, I offer one vote for this discussion.

Dick Purcell

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Post by wbond » Sat Nov 13, 2010 2:04 pm

LH wrote:
Lbill wrote:
Assuming you owned the TIPS ladder when the real yield was at your required return of about 2%, then on the way down to the drop of 0.7%, you experienced some capital appreciation of the bonds.

Do while you cannot withdraw 4% of the current principal, you can withdraw 4% of the principal before the yield drop.
Excellent point. It is investors who are now considering buying a TIPS ladder who are affected. If they'd bought last year, their TIPS would have yielded more than the average 1.3% needed to support a 4% SWR. Now, they're going to have to look elsewhere or decrease their SWR. Not sure where else to look tho - since people like Bill Bernstein are saying that the expected real returns from stocks going forward (considering their volatility) won't be enough to support a SWR higher than 3% either.
1979 the death of equites.

2010 the sickness of equites.

Recency anyone?

break out the crystal ball, and the 1959 gordon equation, both with just wonderful predictive ability for pertinent 30 year timeperiods.

"riskless" TIPS ladders are mythical beasts, its funny it showed up this clearly, this soon though.
Another post in defense of the Gordon model where I calculate what the prediction would have been in 1979.

First, the Gordon equation is an ex-ante estimate of future returns and explicitly recognizes that long-term (decades plural, not one decade) returns have some linkage to the underlying economy.

Second, as is always noted in any extended discussion of the model, one needs to take into account changes in valuation, which are unknowable, but are less important to total return the longer the view one takes. So, in the next six months, the only thing that matters for equity returns is the change in valuation (e.g. delta of P/E or delta of dividend yield). But over thirty years valuation change may contribute 1/3 to your return either way if it doubles or halves, with the rest coming from dividends and growth of dividends.

So let’s actually look at the time period from 8/1979 when the Business Week story was published until 9/2010.

The Dividend Yield on the S/P 500 was 5.07%. Add 1.3% (the number Bernstein uses) for average real growth in earnings/share and you have 6.37%/year real total return predicted long-term. The actual total real return was 7.11% for that 31 year period. A difference of .74%/year: not too bad. Of course, the valuations now are higher. The dividend yield at the end date is 1.97%. This change in valuation annualizes over 31 years to 3.09%/year (or 2.52%/year if you use P/E change). 6.37 + these numbers = 8.89% - 9.46%/year vs. the observed 7.11%/year. This again, is not perfect, but depends on how valuation is calculated, etc., and is relatively close.

The current expectations for the ex-ante ERP favor equities, FWIW, but I wouldn't count on equity returns greatly outpacing the Gordon model predictions long-term: that would require a higher than historic growth in earnings/share or a significant increase in a not particularly low P/E.

All the best, wbond

Sources: financial calculator and Political Calculations.

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