Did you read my guest post on Rockstar Finance on looking at testing Safe Withdrawal Rates from another angle?
If not, I suggest you go there first. If you want to read some more technical details, then see below.
If you want an overview of the Trinity Study then Chief Mom Officer published a very nice summary article that goes into a good level of depth without being overwhelming.
The Trinity Study in Another Dimension
Have you read the important notes? It’s a condition of reading this blog.
In the post I looked at what Safe Withdrawal Rates (SWR) would look like in a world without mean reversion of equities (and note that it’s quite possible that we already live there now). I implemented a thought experiment from the Nobel prize winning economist Paul Samuelson who considered randomly drawing historical annual equity returns from a hat to create a new sequence of returns. Crucially, he considered replacement in drawing the individual returns.
This is the really key part. Since you then get a sequence of returns with historically ‘accurate’ annual returns and volatilities but you destroy any potential mean reversion.
Mean-reversion, or negative serial correlation, is a hotly debated topic, and there is no general consensus to my knowledge. Without doubt equity returns exhibit non-randomness, however there is no simple key to the mysteries of stock price evolution. Any signal is generally swamped by the noise, and no serious equity investor is a ‘chartist’.
The fact is that there are no rules for equities to follow and there is no inbuilt law of the universe that says that equities must outperform bonds, or even cash. There is considerable data to support this assertion, but no cosmic requirement. A stock simply gives the holder part ownership of an enterprise and it might give some voting rights. But it gives no entitlement to returns or any stream of cash or share of profits.
So equities are not like bonds. They are not bonds on steroids, and they do not automatically provide greater returns than bonds. They are more risky and this should be so, since they provide the holder with far fewer guarantees than a bond investor.
Stocks are Risky
If long term equity returns were guaranteed then equity managers would pay the investor to hold their cash (see this post for example). Similarly you could arbitrage the market by borrowing cash and investing in the equity market to achieve a riskless return. Whatever you believe about the market you have to believe in limited opportunities for persistent and substantial arbitrages. Therefore equities are risky; there is a chance that you lose all your money, and a chance that they underperform bonds for a sustained period.
The future could therefore be very different to the past. There is no market force that compels a re-run of past performance. Consequently the Trinity Study has rather limited use. It tells us what would have happened, but tells us little about what could happen. This was the subject of my Rockstar post – what could happen in the future?
Whadya think? A load of baloney? Dangerous tinkering with one of the cornerstones of retirement analysis? Thought-provoking and useful? Comment below.
Want to read some more analysis? Check out Lump Sum or Dollar Cost Average Investing? or Introduction to Sequence of Returns and Buying a Boat in Retirement
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