Jun 7, 2022

A Short Test of the Ed Thorp-ian 2% Rule

Like a tongue seeks out those annoying imperfections in a tooth, I tend to go back to two things over and over here on the blog: 

1) the Nikkei index after 1989 as an example of a tough market that never recovers (yet), and 

2) the Ed Thorp 2% rule which -- along with simulation I've done a million times -- says 2% is pretty close (on average anyway) to a perpetual spend rate for endowments or long-dated trusts. 

So, now, what happens if we take...

  • Monthly Nikkei data from Yahoo finance December 1989 to December 2021,

  • A hypothetical million dollar starter-endowment,

  • Monthly US inflation data from inflationdata.com 1989 to 2021 (this might seem a bit of a mismatch but this is an imaginary confection: a bad index experience rendered in a semi-realistic US-type context. idk), and...

  •  A constant spend of 4% and 2% (so 40k (annualized) and 20k (annualized) at the start of December 1989 and then adjusted monthly for inflation thereafter). And no, I don't think -- or I'm not sure -- a 2% constant spend is really what Ed was talking about. I'll look at a % of portfolio 2% a little later and add it at the bottom in a post-script. [1]
...and then we ask ourselves...

  1. How long did the money last?

  2. Is this setup even remotely realistic? 
...to which we can provisionally answer...

  1. How long? The 4% spend lasted 127 months or 10.6 years. The 2% spend lasted 187 months or 15.6 years. Ooof!

  2. Remotely realistic? Sure, why not? The future could actually be even worse (or better of course) and we haven't even discussed things like taxes, fees, war, chaos, bonds, etc. Anyway: doesn't matter, this was just a test of the mere stub of an idea. 

... and then maybe we can also interpret the answers thusly:

Concentration into one bad asset, consumed with even a supposedly "perpetual" spend rate, starting at an inopportune time, combined with the long lives of endowments or early retirements, can produce something that does not work very well. Or maybe another conclusion is that this is a closet case for early annuitization with or even without inflation protection. Or alternatively: learn to make cardboard signs and stand at intersections. At a minimum, I suppose we should at least acknowledge the potential beneficence of multi-asset global asset allocation. 


---------- notes ----------------------------------


[1] I ran a % of Portfolio with a 2% rate. If I did it right -- and the result surprised me so maybe I got it wrong, idk -- it took 2 and 1/2 years for the %P spend to fall below 50% of what a real, constant, inflation adjusted 2% of initial Endowment would be -- and never crossed back up again...and found a low of 8% of the real constant rate. That's harsh enough that I'm not sure about this result. TBD.  I mean, it is a super simple spreadsheet thing so it seems obvious but...






5 comments:

  1. The summary data provided in “An International Perspective on Safe Withdrawal Rates from Retirement Savings: The Demise of the 4 Percent Rule?” by Wade D. Pfau, 2010
    might be helpful. A quick look at Table 3 therein gives a SAFEMAX of 0.47% for Japan; although that did happen from 1940 - so prior to your sample.

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    Replies
    1. .47! Think about that. At that point it's almost like why bother? Or maybe we can say that it is getting indistinguishable, more or less, from zero or at least the cardboard sign scenario. To fund a US100k lifestyle one would need a little more than something like 21M on a spend/spendrate basis. wtf

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    2. Given the sheet I'd constructed, I solved for "30 years" and got a .83% spend before fees and taxes. Still ridiculous imo.

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    3. Same Pfau paper mentions that if the analysed sample is restricted to post war years (1946 to 2008/2009) SAFEMAX is a whopping 1.56% starting in 1946. Is the difference [vs your calculation] down to differences in the two respective data samples or your use of US inflation data. IDK, but, in any case, a low SAFEMAX is to be expected from Japan.
      BTW, Pfau's value is also before frictions and with a perfect foresight assumption - which for Japan seems to be 100% equities.

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  2. Warn me next time :)

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