I’m not just finding junk as I clean out my timemagazine.com inbox. I also come across interesting stuff, like this long-ago e-mail from reader Darrell Balmer:
In Irrational Exuberance, Robert Shiller highlighted the increased probability of high equity returns over a ten year period when the price to average preceding 10 year earnings is low. Conversely the probability of low returns is increased when the price to average preceeding 10 year earning is high.
In Unconventional Success, David Swensen recommends retirees tailor their fixed income allocation percentage based on when money is needed. For expenses in the next two years, 100% fixed income, then 75% for years 3 and 4, 50% for years 5 and 6, 25% for years 7 and 8, and 0% for years 9 and beyond.
Adjusting Swensen’s recommendation with Shiller’s data suggests a strategy something like the following.
When P/(avg 10)E is in lowest quartile, use fixed income at 100%, 75%, 50%, 25%, 0% for years 1&2, 3&4, 5&6, 7&8, 9 and beyond respectively.
When P/(avg 10)E is in second quartile, use fixed income at 100%, 75%, 50%, 25%, 0% for years 1 to 3, 4&5, 6&7, 8&9, 10 and beyond respectively.
When P/(avg 10)E is in third quartile, use fixed income at 100%, 75%, 50%, 25%, 0% for years 1 to 4, 5&6, 7&8, 9&10, 11 and beyond respectively.
When P/(avg 10)E is in highest quartile, use fixed income at 100%, 75%, 50%, 25%, 0% for years 1 to 5, 6&7, 8&9, 10&11, 12 and beyond respectively.
I like this approach because it incorporates the inescapable Shillerian truth that stock prices overshoot, but does so in a way that’s not so much market timing as risk management.
