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Retirement Income Portfolio Survival

Legend believes understanding the dynamics of retirement income portfolio risk can be crucial to investment success.  The survivability of five hypothetical retirement portfolios over the 20-year period ended December 31st, 2018 shown in the accompanying table is not intended as investment advice but is intended to help the reader better understand retirement portfolio risk and conquer perhaps the worst of all financial fears: running out of money in retirement.  The data is based on a continuing professional education session by Professor Dr. Craig Israelsen, an independent economist.

The results of the five portfolio risk levels illustrated a range from very conservative to aggressive.  All five portfolios assume a retiree withdrew 5.0% of the portfolio value annually, and annually increased withdrawals by 3.0% to keep up with inflation.  

Please note that a 5.0% withdrawal rate is highly aggressive and that a couple of portfolios almost ran out of cash after only 20 years.  A more reasonable withdrawal rate is 1.0% to 2.0%, if the money is to last over 30 to 40 years (For example, if one retires at age 60 and lives until age 90, that is the normal joint life expectancy.  This also assumes no one lives past age 90 in this example or there are not any further improvements in healthcare over the next 30 years.).

When looking at the chart, it is best to pick whichever starting balance — $250,000.00, $500,000.00 or $1 million — best applies to the reader’s situation.

What stands out is that the most diversified of the five portfolios outperformed considerably better — broad diversification worked!  For many,  diversification may come as no great surprise that it worked; conventional wisdom and academic research hold that diversifying is wise.  Remarkably, diversification worked even though this was a 20-year period of low returns on stocks.

Stocks only, is a riskier investment in a retirement portfolio, showed an internal rate of return over the 20 years of just 2.69% — only six-tenths of 1.0% better than the least risky of the five portfolios, the one 100.0% invested in short-term Treasury Bills.  The return for the S&P 500 (An index of primarily Large U.S. Stocks) for the next 12 years is expected to return a -1.0% or perhaps less, to at most a +1.0%.

Why did stocks perform so poorly?  The 20-year period started in 1999, at the peak of the dot-com bubble.  The Standard Poor's 500 index did not recover until 2006, and then it dropped again in the bear market of 2008.  A retiree, in this example, would have picked a terrible 20 years to be a speculative or at least very aggressive investor (100.0% invested in stocks).

Over the much longer 49-year period, the S&P 500 stocks did outperform cash by a huge amount and they also outperformed a diversified portfolio.

The point is that even in this terrible period for stocks, the growth engine of a retirement portfolio, a broadly diversified portfolio, outperformed.  The next 12 years are likely to be as poorly performing as the last 20 years or perhaps even worse.  However, this illustrates how broad diversification helped a retirement portfolio survive through a period in which stocks performed unexpectedly poorly. 

Please note that the reader should discuss all strategies stated above with their investment advisor before implementing any of the above listed strategies.

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