By now, you may have noticed that consumer financial magazines such as Money, Smart Money and Fortune have published their 2011 Investor Guides.  These guides provide you with all the needed information to make informed decisions with your investments and outsmart the markets.

If only that were the case. Let’s rewind the clock and review their results for 2010.

Money Magazine told us that small company stocks would suffer, since they perform better in the early stage of a bull rally. Because of this, Money urged readers to focus on high quality blue chip stocks.

And the 2010 results were:

• Russell 1000 index (large stocks): 16.10%
• Russell 2000 index (small stocks): 26.85%

Contrary to Money Magazine’s prediction, small stocks outperformed large stocks in 2010 by a wide margin.

Money also recommended ten large company stocks to capitalize on the upcoming outperformance. Unfortunately for the readers who followed the advice, the picks had an average price-only return of 6.3% versus 16.10% for the Russell 1000 index.

Smart Money also picked up on this trend, recommending large stocks over small stocks. They offered 12 stock picks to take advantage of the trend.

Smart Money’s 12 stock picks produced an average price-only gain of 7.5% for the year versus 16.10% for the Russell 1000 index.

Fortune Magazine had a different outlook claiming, in their words, “Making judicious stock selections will be crucial in what is likely to be a topsy-turvy year.”

Fortune recommended ten different stock picks for their readers. And, although Fortune had a great performer in Salesforce.com (up 78.9%), the average price-only return for their picks was 1.75% versus 16.10% for the Russell 1000 index.

That’s not what we would call judicious stock selections.

Comically, in the same issue of Fortune there was a useful article on the appeal of a simple index fund approach: “Stock picking, whether you do it yourself or pay a pro to do it for you, is a mug’s game,” they wrote. “You’re better off buying and holding a cheap, diversified, and consistent index fund, which passively invests in the stocks listed on a broad market benchmark.”

Good advice, but we know it won’t be long before catchy cover stories such as “Top Ten Stocks for the Year Ahead” are crowding the magazine racks once again.  To be sure, last year’s results offer another example of how easy it can be to miss the rewards the capital markets have to offer.

The need for retirement income doesn’t end with the onset of retirement.

A new retiree’s focus shifts from building wealth to managing and creating retirement income. One major challenge is to make the investment portfolio supply retirement income for life—through different economic and market conditions.

Experts have studied portfolio longevity to help retired investors reduce the odds of exhausting their wealth too soon and found three main issues that drive portfolio endurance:

• asset mix
• spending level
• investment time frame

Certain parts of these issues are within an investor’s control while others are not. Let’s briefly consider them.

Asset Mix

Asset mix describes the ratio of stocks to bonds in a portfolio.

This determines risk exposure and expected performance, and is an important decision investors of all ages can make. Historically, stocks have outperformed bonds and outpaced inflation over time.

So, the larger the stock allocation, the greater a portfolio’s expected return—and risk.

Keep in mind that risk and return go together. A higher allocation to equities increases the risk of experiencing periods of poor returns during retirement.

However, growth can bring higher retirement income, inflation protection, and portfolio endurance over time.

Spending Level

Portfolio withdrawal is typically described in specified dollars (e.g., $50,000 per year) or a percent of annual portfolio amount (e.g., 5% of assets each year). Neither method is ideal, however—and for different reasons. Briefly consider each one:

• Specified dollars: withdrawing a fixed amount each year and adjusting it for inflation can provide a stable retirement income stream and preserve your living standard over time. But the portfolio may survive only if future withdrawals represent a small proportion of the portfolio’s value.

• Percent of annual portfolio value: withdrawing a fixed percentage of assets based on annual asset value makes it unlikely that you will deplete retirement assets because a sudden drop in market value would be accompanied by a proportional decline in spending.

Investment Time Frame

Investment time horizon may be the hardest to estimate, especially when your horizon mirrors your lifespan.

In this case, you can only guess how long your portfolio must support spending.

Time frame forces a tradeoff between the short and long term. Retirees with a longer investment time horizon might choose a higher exposure to equities. But they may have to offset this risk by being flexible about spending over time.

Elderly retirees and others with a short time horizon may choose a less risky allocation or a higher payout rate, although they can experience rising spending levels, too.

Considerations

Planning involves assumptions about the future—assumptions that may not pan out.

Although you cannot avoid assumptions, you can ask whether they are practical and consider how your lifestyle might change if future economic and financial conditions differ from your projections.

This question has been coming up a lot lately in the media and some academic journals. Thinking Modern Portfolio Theory died last year is based on the misconception that Modern Portfolio Theory will guarantee against a loss.

That is simply not the case. What MPT believes is diversification to a portfolio, which over the long term can potentially reduce a portfolio’s volatility versus a single asset portfolio.

According to a recent article in Investment News:

• MPT does not guarantee against a loss
• Fixed income helped reduce the amount of loss in many portfolios last year
• Many advisors are finding that their clients had too much equities and not enough fixed income for their risk tolerance

Remember, when investing in a diversified portfolio, you will experience negative returns periodically.

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From the January, 2000 Smart Money Magazine:

“The Underachiever’s Club – Thanks for Nothing: Sixteen mutual funds reopened to new investors in 1999. But returns for these three make you wonder why they bothered.”

The three mutual funds highlighted in Smart Money’s “Underachiever’s Club” were:

• Lord Abbett Small-Cap Value
• Neuberger Berman Genesis
• Vanguard Windsor

The Smart Money article focused on each fund’s market underperformance since reopening – a period of only six months! Six months is hardly enough time to judge an investment or investment strategy.

Of course, it’s easy to find winners and losers using hindsight. The problem was, this article highlighted these funds as losers although they were on the verge of outperformance.

Look at the subsequent five-year (2000-2005) compound returns for each of Smart Money’s “underachievers” versus the general market.

• Lord Abbett Small-Cap Value: 17.05%
• Neuberger Berman Genesis: 17.44%
• Vanguard Windsor: 7.62%
• S&P 500: -1.13%

Investing based on tips from the financial media is dangerous to your wealth and will not help achieve your goals.

Finding an advisor you trust and developing a plan with that advisor will!

*This article does not represent a recommendation to buy or sell the mentioned funds. Past performance does not guarantee future results!

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