Because the values of equities are volatile and can undergo
large, long-lasting changes in value, predetermine the maximun percent
of exposure of the portfolio to loss due to changes in value of equities
(to preserve value) and the minimum percent (to take advantage of
returns, i.e., dividends and rising value of equities). This should be
done very infrequently. See notes below.
Choose a model for projecting the "expected" value of the "Shiller PE10". See notes below.
Periodically look up the "Shiller PE10" using the link below by the corresponding cell.
For example, for a current PE10 of 31, a minimum projected exposure of 7%, and a maximum exposure of 15%:
Using the median PE10 over 150 years as the expected PE10, the minimum equity percentage would be 15%, and the maximum would be 32%.
Using the trend PE10 over 150 years as the expected PE10, the minimum equity percentage would be 25%, and the maximum would be 54%.
Minimum % equity risk threshold:
Maximum % equity risk threshold:
16.32 (median for 1872-2020) 22.33 (trend for 1872-2020, projected to today)
The objective here is to limit risk, not to maximize gains.
This gives no indication when to invest; just how much within predetermined risk limits, meaning:
It is intended that the "equity thresholds" (i.e., maximum and minimum percentages of the portfolio allocated to equity) be predetermined rather than chosen in response to perceived market conditions.
To avoid attempting market timing, one can
set PE10 thresholds at which to adjust allocation to keep it within the
risk limits.
For example, one could choose to re-allocate
only when PE10 rises or falls across a boundary divisible by 0.5;
thus, when the PE10 is 33.3, do nothing till
it falls to 33.0 or rises to 33.5, and then only keep percent equity
within the risk limits.
To avoid excessive trading, increase the spread between minimum and maximum equity thresholds.
Modeling the expected PE10 is not a scientific exercise because it depends on the choices of whoever participates in the market.
Therefore, this calculator provides two models for projecting the expected PE10:
Use the median PE10 for 1872-2020. Choose
this model if you believe that possible returns on capital investment
are comparatively unchanged over 150 years.
Use the linear trend of PE10 for 1872-2020.
Choose this model if you believe that possible returns on capital
investment are have gradually decreased two-fold over 150 years.
A linear regression model assumes that observations from one date to the next are independent, which is false.
That being said, this is a straightforward way to project PE10 with a two-fold decrease over 150 years.
There is nothing mysterious about the calculations of minimum and maximum percent equity. Each is computed as: