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Historical vs Monte Carlo

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(@pizzaman)
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Very interesting article that indicates that momentum investing is a better way to invest: https://www.marketwatch.com/story/momentum-stocks-can-give-you-an-edge-researchers-say-11638497577

This is something Monte Carlo simulations do not take into account.


   
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(@hines202)
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Enron was a momentum stock, until very suddenly it wasn't 🙂 Same with Luckin Coffee, and so many others. This smells of market timing, which usually doesn't turn out well, over time at least. We've been in a hot market for 11 years, so pretty much any strategy has worked. Have fun in your 'fun' brokerage account, and speculate away, but do what time has shown has always worked in your critical accounts.


   
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(@pizzaman)
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...do what time has shown has always worked... Gee Bill, are you saying that looking back in history has some value, like backtesting 😍


   
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(@pizzaman)
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Hot market for 11 years is the definition of momentum! You will make more money following "momentum" for 11 years, even taking into account a few (certainly not 11) down years, you will be ahead. That is what history has shown us. 🙄 No disrespect intended 😏


   
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(@hines202)
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@giovanelli766 Sure, history teaches us quite a bit. My point was that it should not be the only basis for making decisions, as it seemed you were inferring by saying there was no need for international exposure in a portfolio. We arm ourselves with that knowledge, and take a prudent look at current conditions and likely future conditions, and make decisions based on some weighting of those factors.


   
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(@pizzaman)
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@hines202 Just some good natured ribbing 🤗 Good points!


   
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(@hines202)
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@giovanelli766 Oh great, someone had to mention ribs just before dinner 🙂


   
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(@golich428)
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Thanks for the reference to Kitces' paper. I read that a few years ago and it prompted me to modify how I look at my ROR assumptions. One approach that I have used to help account for current market conditions that may suggest lower returns for both equities and bonds in the next 10 years is to subsequently increase the ROR over the next 30+ years in the model. I do use historic ROR data to estimate the reversion based on the first 10 years of assumed returns versus the next 20 years. This somewhat addresses the reversion to the mean that Kitces referred to but in kind of a clunky way. It is easy to implement in Pralana and although not perfect, it is (in my opinion) better than using low returns for 30+ returns even if you have a view that they will be suppressed over the next 10 or to use historical data that may not take into consideration the market conditions when one retires.


   
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(@pizzaman)
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@golich428 That's sounds like a great idea 🧐 I am going to try it and see what happens when compared to 30+ years of the same average ROR.


   
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(@lane568)
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So what was the answer Pizzaman?


   
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 NC
(@nc-cpl)
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@golich428 Greg - Can you share your steps for doing this? I too want to make that same adjustment as I entered pretty low ROR for now but anticipate a return to "normal" at some point down the road. Also curious what you chose for your ROR's for assets classes over time as I'm always interested in seeing how what I've selected syncs up with others....


   
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 NC
(@nc-cpl)
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@hines202 Bill - I too like the bucket system concept, but am wondering about the manner in which you go about it....i.e., which accounts in a portfolio do you designate for each bucket, or, do you determine what is in each bucket by the "spending order sequence" as prescribed by PRC (lets assume bucket 1 is a checking/savings acct)?

Further, do you actually move assets to different accounts (buckets), or do you simply identify or "tag" them as being associated with a specific bucket but let the funds remain where they are? Moving stuff around might make things very easy to see, but selling just to get them in buckets could generate a lot of undesired gains.

On bucket replenishment...in theory, you would keep 18-24 mos. of immediately liquid assets, another 6-8 years tagged for Bucket 2, and the remainder for Bucket 3. But to maintain the Bucket 1 balance, you'd be constantly liquidating to replenish what you're spending (I have not seen anywhere where they suggest running the balance down to zero). With that in mind, you kind of commit to having to sell some assets when the market is down to replenish B1. Thoughts?

We can bump this to a new thread since its gotten off-topic.


   
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(@hines202)
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@nc-cpl The bucket system is a high-level view of amounts of the nest egg in different asset classes. Typically it's 2 years in liquid cash, 3-5 years in bonds/fixed income, the rest in equities. But it should looked at also from an asset allocation perspective - for example, for folks with a big nest egg, that can result in a much more aggressive AA than they're comfortable with (90/10 for example). Conversely, it gives some normally risk averse people the assurance to go with a more aggressive AA, knowing they can ride out a seven-year downturn without selling equities that are devalued, waiting until they recover.

Then you get into asset location - where the funds are. That becomes more of the secret sauce recipe, right? It's aside from the buckets really, and gets into a proper algorithm of tax optimization, etc - what Pralana and/or a good retirement planner does for us.

What a lot of people who use this do, is each year in Jan or late Dec they'll either move one year of cash to their checking account for that years' spending budget/allowance, or just set up monthly transfers as a 'paycheck'. Ok, so now it's a year later. The cash account has only one year of money in it! It needs to be refilled. The buckets need to pour down into each other. You look at how the segments have done - if it was a good year for equities (like the last 11-12!) you might decide to sell some lots strategically (any loss/gain harvesting to do in brokerage accounts?) and fill that cash bucket back up to two years worth. If it was a bad year for equities but a good year for bonds (i.e. 1999-2013, the "lost decade") you might take those bond profits to refill the cash bucket. If neither were up, you might just wait a year and do nothing - that's why you have two years of cash there.

It's really a more "feel good" way of just doing annual rebalancing, as Kitces outlined in one of his articles on buckets, although I think he had a somewhat different take on the above.


   
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(@golich428)
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@nc-cpl The way I implemented the approach was to create (name) two asset classes for the different time periods. For example, for the first 10 years I named the stock allocation Stock10 and for the second 20+ years, I named the stock allocation Stock20. Then in the Asset Allocation tab, you can specify the time periods and allocations for each period. The values I used in the first 10 years were based on forward looking expected returns estimated from current market conditions.

When I updated my plan this year (2022), I abandoned this approach because it does add some additional steps and I plan on funding all my essential and part of my discretionary expenses with guaranteed income. I have two pensions that allow me to take lump sum distribution or monthly income payments. My current plan assumes I take the monthly income option but that is still a few years away so who knows what I will eventually do.

I was also stress tested my new plan with the low expected returns for all time periods and my plan still worked. This makes the rate of return discussion much less important. My current estimate of expected nominal rates of return are 5% for equities and 1.5% for bonds.

When I did the historical analysis, there was a pretty strong correlation between the first 10 year returns and the safe withdrawal rate. That is what prompted me to look at the next 20 year returns. The data did indicate moderate mean reversion: When rates of return were very low the first 10 years, they were generally much higher the next 20 years. The reverse holds true as well. For returns closer to the long term average, the reversion was not as strong. This stuff is not physics, it does not follow any well defined physical laws so there will always be uncertainty. I like to prepare versus predict.

Hope this helps!


   
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(@pizzaman)
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@nc-cpl Getting to your first question, my wife and I each have a regular IRA and a Roth IRA. I am a few years older, so what we did was set up an online high-yield saving account which contains our 2-3 years of cash used only for unexpected events such as a stock market crash, forest fires and asteroid strikes 😱 . The account we use for annual expenses comes out of my regular IRA which is mostly in TIPS. My wife's IRA and both Roth's are 90% plus in US market index funds. Once my regular IRA is depleted (which will be before RMD's would start) we will switch to my wife's regular IRA, then the Roth's. We did a gigantic Roth conversion in March 2020 to take advantage of the stock market drop, so over 50% of our retirement funds are now in Roth's. We depleted most of our taxable account paying for the taxes from the conversion, but the long term capital gains were at 0% tax rate, no harm no foul. So far so good 😉


   
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