Prime Harvesting bond levels: the problem with averages

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Just like harvesting stocks…

The last time I wrote about Prime Harvesting (from Michael McClung’s book Living Off Your Money: The Modern Mechanics of Investing During Retirement With Stocks and Bonds) I ended up by noting that Prime Harvesting doesn’t really care how many bonds you own. That’s in stark contrast to much (though not all) other retirement advice.It is one thing to say, after reading a book, “Yep, Prime Harvesting looks great!” But will you still think that if you’re 82-years old and are 100% stocks? Even if some people tell you not to worry about being 100% stocks?

McClung provides the following table, which for a given (starting) stock percentage shows how Prime Harvesting fared.

Portion of Figure 26 from the book Living Off Your Money

Let’s start by looking at Bond Average. For a 60% stock portfolio, the Bond Average is 48.90%. That sounds alright, doesn’t it? But averages can also be a bit deceiving. Let’s try to dig into a bit more detail…

My simulations differ from those in the book:

  • McClung uses SBBI data for stock and bond returns. That is not public information. SBBI publishes a book every year. The latest edition is usually over $100. But hobbyists can buy a slightly older edition much cheaper. There aren’t any copies of it in Vietnam. So I make do with data from Simba’s backtesting spreadsheet which in turn is largely based on Schiller’s data.
  • McClung uses a slightly diversified equity portfolio: 70% total market, 10% small company stocks, 10% large value stocks, 10% small value stocks.

Taken together this means that my results won’t match McClung’s numbers exactly. But (if I’m not making any mistakes) they should generally be the same ballpark. In any case, the Prime Harvesting strategy (if it works) shouldn’t be overly sensitive to exact portfolio construction or the returns used.

With a 60/40 portfolio I find that the Bond Average is 43.3 (48.9); Lowest-Bond Average is 19.7 (23.7); Highest-Bond Average is 62.4 (70.4); the Success Rate is 99.3 (100); Average Remaining is $2.7 million ($5.5 million).

(McClung’s numbers are in parentheses.)

Everything is pretty close with two exceptions:

  • In my simulations, 1966 was a portfolio failure, while it succeeded for McClung. This is conceivably down to portfolio construction and different data sets (Schiller vs. SBBI). Even if it succeeded in McClung’s simulation, I assume it didn’t succeed by very much.
  • The Average Remaining is wildly different. I have no idea why. From the book it isn’t 100% clear whether this is inflation-adjusted or nominal. I used nominal; if I used inflation-adjusted the numbers would be even further off. Does portfolio construction and different data sets lead to such dramatically different Average Remaining? I’m not sure.

So overall I’m reasonably confident that my results are close enough to use for a deeper dive. (Though not 100% confident due to those Average Remaining numbers.)

Let’s look at the bond averages again real quick:

  • Average: 43.3%
  • Lowest average: 19.7%
  • Highest average: 62%

Looking at that, it is easy to think. “Okay, so my bond percentage will drop to around 20% for a bit, will go up to around 60% for a bit, but will mostly be around 40%. That sounds acceptable, sign me up!”

The problem is that averages can obscure some information. Let’s take a look at a 1940-retiree and their bond percentage under Prime Harvesting:

This retiree has a Bond Average of 40.3%, which sounds perfectly reasonable. But the average is a result of 15 years under 40% and 15 years over 40%, including nearly a decade under 30%, and a single year around 5%. That means when you are 75-years old your portfolio is 95% equities, 5% bonds (albeit temporarily).

To take an even more extreme example, a 1920-retiree has a Bond Average of 26.4%. That’s already a bit below the overall average of 43.3%. Let’s look at the year-by-year portfolio composition:

Chart 2

That’s 7 years with 100% equities (approximately age 75 to 82). The very high bond ratios in the last decade of skew the average upward.

Looking at the results, in 44 out of 144 retirements, the bond percentage will go to 0% at some point. So 30% of retirees will have a 100% stock portfolio for at least some of their retirement. It might only be for a single year, like the 1974-retiree who saw markets finally turn around just as she ran out of bonds.

Chart 4

But if you had retired just one year earlier, in 1973, you were at 0% bonds for more than one year.

Chart 5

That’s because you ran out of bonds and started eating into your equities. And once you do that, it becomes progressively more difficult to ever reach the 120% harvesting point.

For some retirees, they can never make it back.

Chart 6

So…what do I make of all that? Honestly, it leaves me a bit more hesitant about Prime Harvesting. Living with 0% bonds in retirement just sounds…I’m not sure how realistic that is for most retirees, no matter what the data says.

And when you look back at McClung’s chart comparing Prime Harvesting to traditional Rebalancing…

Figure 26 from the book Living Off Your Money

I can see a lot of people deciding that the extra return (in some cases over 2% but in others under 0.5%) from Prime Harvesting isn’t worth the heartache of extra portfolio volatility from low bond percentages.

Would I use Prime Harvesting? I’m much more on the fence than I was before. But I still like the general idea (of “harvesting” stock gains and spending from bonds first to shelter stock growth) so I’ll continue thinking about it…..

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Learn how to enjoy early retirement in Vietnam. With charts and graphs.

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