What’s the hardest part of the retirement decision? For many its taking the leap of faith that financially what’s worked in the past will continue to work in the future. And often the start of every single year, during those early years of retirement, brings the anxiety right back again. I’m in my ninth year of withdrawals and while the anxiety has lessened by orders of magnitude, it is still there. Someday I may recount the year by year story, maybe after year 10. In today’s post I want to look back a bit in order to look forward. We’ll go back to the beginning of the year 2000 and the year 2008 and look at the decisions facing those retirees. Then we’ll look at how those portfolio decisions performed through the end of 2013.

For every retiree since 1996 the retirement decision matrix, SWR decisions vs stock allocation, has looked exactly the same. The table below shows what those choices are:

SWRs by allocation May 2014

Why have the historical SWRs not changed since 1996? Because, as I show in this post, the SWR is solely determined by the worst case retiree in history which happens to be the 1966 retiree. That 1966 was the worst case period was not know until that 30 year retirement period was over in 1996. Lets assume that the 2000 and the 2008 retiree chose an SWR of 4.39%. They then were faced with several investment portfolios offering different levels of diversification and risk management. They used data similar to what I presented in this  post . I’ll use the various diversified IVY portfolios, their timing relatives, and the Permanent Portfolio. How have the 2000 and the 2008 retiree fared if they chose one of those portfolios? Here is the data.

Diviersified portfolios and the modern retiree

First, lets look at the year 2000 retiree, 14 years later. Everyone of these portfolio choices would have worked out just fine compared to the worst case 1966 retiree. In every case the more diversified portfolios did even better and the timing/trend following portfolios did even better. Only the the retiree that chose the standard 70% US stock, 30% US Bond portfolio, ended with less money than when they started with. Several of the portfolio choices would also have given the 2000 retiree the opportunity to adjust their withdrawal rates higher due to the great performance. Diversification works and it paid off in spades. All as expected.

Now, lets turn to the 2008 retiree. Hmm, notice something interesting here. For the last 6 years, diversification has basically failed to give a portfolio much benefit. The bull market in US stocks has been quite powerful. Only the two most aggressive portfolios, that combine timing and momentum (GTAA 3 and GTAA 6) beat the standard 70/30 portfolio substantially. What should we make of this? Time to abandon diversification all together? I hope you don’t think so. The last 6 years of US market out performance does not trump the long term historical data. Nor should it. If anything I think it suggests the diversified portfolios are set to outperform going forward. And so far, in 2014, that is proving itself out. But hey, that’s forecasting and who knows.

There is something more important here to take away. While it may be intellectually easy to say, stick with diversification, emotionally, while looking at your portfolio statements, it is a different story for most people. Any strategy you choose will have periods where it under performs other strategies. And those periods of under performance can be significant. This uncertainty can make taking the leap into retirement quite scary. How do you deal with this?

This is a concept called base rates which I’ve discussed in my quant strategy posts but the concept applies here as well. How best to deal with base rates less than 100%, i.e. that your portfolio choice will under perform for various periods often a lot longer than you feel comfortable with? The best way is not to go with one strategy all or nothing. A part of your retirement portfolio could be a standard 70/30 stock bond portfolio, another part could be more broadly diversified IVY B&H 13 for example, etc.. This way during any given period part of your portfolio is outperforming. This I think is the best way to deal with the emotional factors involved in retirement investing.

In summary, the 2000 and the 2008 retiree while both doing just fine with any of the various retirement portfolios discussed here have had quite a different experience. While for one diversification has been a boon, for the other it has been mostly a meh. This is quite the exhibit of the uncertainty in retirement. It is important I think to let the long term record speak for itself but at the same time choose a few of the strategies to make the emotional aspect of retirement investing easier to deal with and thereby increase the chances of success.


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4 thoughts on “ Standing on the edge: diversified portfolios & the modern retiree

  1. Sage advice about multiple strategies. Related to the wide variation on returns that result from the same strategy being implemented at different times, is the issue of choosing specific vehicles to implement a general strategy. For example, I have been using FINVIZ to track some Trending Value portfolios started back in June, July, August, and September and the returns have varied from between 1 and 10% depending on the specific 25 stocks chosen. All of these portfolios are underperforming the S&P, granted the base rate for 1-year period is only 84.6% compared to the 99.2% for 3-year rolling period, so I am waiting a few more years before juding the success of the strategy.

    1. Jeff, I don’t think the variation in the diversified ETF portfolios has much to do with the implementation vehicles. For myriad of reasons different strategies perform differently through time. International beats domestic for a while, credit beats equities for a while, etc.. and vice versa. Call it reversion to the means, whatever…

      As far as quant portfolios goes (like Trending Value), then yes, implementation details can make or break performance. For example, the portfolios generated with FINVIZ don’t include SHY or EV/EBITDA as factors so they will behave differently than the designed system. I have TV tracking portfolios with all the factors generated in June, July, and Aug, and only the June one is under performing the market. I use Portfolio123 for this. I tested a FINVIZ TV portfolio in Portfolio123 and found the performance was 6% a year less than the TV with all the factors going back to 1999. So, significant.

      I’ll be posting much more on quant ports going forward.


  2. “There is something more important here to take away.”

    I agree that the philosophy vs emotion conundrum is one of the biggest dangers, if not the biggest danger in investing. I think everybody needs to find their own way to get comfortable with the dichotomy, and desensitize their emotional response to a point where they can discount it. The usual advice is not to look at your portfolio very often, because you’ll get scared by the volatility, and be tempted to act emotionally. For me, the opposite has worked – I look at it all the time and don’t act, in the hope that when I too am investing for a living I have completely desensitized my emotional response. These days I look at my net worth EVERY DAY on personal capital to that end, but I’d already done it well enough that in 2008/2009 I didn’t panic, and made some very rewarding investment decisions in 2009/10.

    1. Dave, couldn’t agree more. Every investor needs to find a ‘system’ or ‘process’ that can work to keep behavioral/emotional mistakes at bay.

      I’m also one of those that looks more often than not. I’ve found that most people are not like that.


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