Saturday, December 10, 2011

Valuations-Adjusted Wealth

Related to my article on "safe savings rates," I discussed how valuations were linked both to how much wealth could be accumulated with a given savings rate (or what savings rate is needed to achieve a wealth target), and what withdrawal rate would be sustainable over 30 years. High valuations tend to mean that someone could reach a wealth goal with a low savings rate, but would then also experience a low withdrawal rate. Meanwhile, low valuations tend force retirees to use a higher savings rate to meet a target, but could then get away with using a higher withdrawal rate anyway.

Individuals from Virginia to Texas, and perhaps somewhere in between, have suggested making an adjustment to the wealth accumulation for valuations. Something like a normalized wealth accumulation.  I finally just now checked this.  Using a 10% savings rates, I checked how much wealth could be accumulated after 30 years of savings in real inflation-adjusted terms. 

Then I multiplied this amount by the median value of PE10 over the historical period (1881-2010 for PE10 values) and then divided it by PE10 for that year.  This would adjust wealth downward when PE10 is high, because the fraction is less than 1, but would adjust wealth upward when PE10 is low, because the fraction is greater than 1.

I think the idea was that this adjusted curve should be rather flat.  

But it is not really all that flat after all.

In looking at this following figure, I can't come up with any story to explain it, and I'm open to suggestions.

The valuations-adjusted wealth accumulations were quite high in the 1960s.  But surprisingly/interestingly, the accumulations are low around 2000 when valuations were at an all time high. I can't really come up with any clear explanation for the movements in the red curve. Perhaps there is no deeper meaning to this figure.  What do you think?

1 comment:

  1. Thanks Rob. When valuations are low, retirees and prospective retirees can take some comfort, at least, that the markets have always eventually rebounded.