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.

Many investors understand the need for portfolio management.

Unfortunately, most investment professionals work very hard to make their portfolio management extremely confusing.

• They have a vested interest in creating investor confusion.
• They use jargon designed to intimidate you and make it difficult for you to understand.

But portfolio management is actually not that complicated if you stick to five key concepts for portfolio management success.

Concept One: Utilize Diversification Effectively to Reduce Risk

Most people understand the basic concept of diversification: Don’t put all your eggs in one basket. However, no matter how sophisticated you are, it’s easy to get caught in a trap. Proper diversification is a major key to successful portfolio management.

Concept Two: Dissimilar Price Movement, Diversification Enhances Returns

If you have two investment portfolios with the same average or arithmetic return, the portfolio with less volatility will have a greater compound rate of return. You want to design your portfolio so that it has as little volatility as necessary to achieve your goals.

Concept Three: Employ Asset Class Investing

Many investors feel that they could have executed better than they did during the last few years.

Unfortunately, most investors are using the wrong tools and put themselves at a significant disadvantage to institutional investors. The average investor who uses actively managed mutual funds is trying to fix a sink with a screwdriver, when they really need a pipe wrench. You need the right tools.

Almost all investors would benefit by using institutional asset classes due to:

1. Lower operating expenses
2. Lower turnover resulting in lower costs
3. Lower turnover resulting in lower taxes
4. Consistently maintained market segments

Concept Four: Global Diversification Reduces Risk

We’ve all read about the concept of a “global village”—that we’re getting closer and closer together.

Technology is creating a new paradigm in which businesses around the world are tied together, just as markets are now tied together. International investments should be a part of your portfolio.

Concept Five: Design Portfolios That Are Efficient

The process of developing a strategic portfolio using Modern Portfolio Theory is mathematical in nature and can appear daunting.  This concept boils down to one simple point: for every
level of risk, there is some optimum combination of investments that will give you the highest rate of return.

Given today’s market volatility, one of the most important things you can do as an investor is to ensure that your investment plan is current. Your plan should examine where you are now and where you need to go to
realize your financial goals, and should also identify the gaps you need to overcome.

With the dawn of a new decade arrives the financial media’s recommended investments.

Articles with attention grabbing titles such as “10 Stock Investments for the Next Ten Years” entice readers with promises of market beating returns.

But should you follow media’s investment recommendations? Consider the following articles published ten years ago.

In August, 2000, a Fortune magazine article presented “10 Stocks to Last The Decade.”

How would these ten stocks have performed if you spread your investments equally among each pick versus the market and a fully diversified portfolio*?

• Fortune’s 10 Stock Investments:  -44.21%
• S&P 500:  -7.26%
• Diversified Portfolio: +81.04%

Time period – August, 2000 through November, 2009.

Fortune’s stock picks drastically underperformed both the market and a fully diversified portfolio.

A second article by The New York Times asked for Buy and Hold picks from “10 very smart, very successful investment professionals…”

So how did these stock picks fair versus the market and a fully diversified portfolio?

• New York Times:  +25.17%
• S&P 500: -4.29%
• Diversified Portfolio:  +84.35%

Time period – February, 2000 through November, 2009

The New York Time’s picks beat the market but it seems a passively managed diversified portfolio drastically outperformed these “very smart, very successful investment professionals…”

Think twice before rushing out and investing your money in any of the media’s picks for the next ten years!

Having a financial plan and a fully diversified portfolio based on this plan is the best bet when investing for your goals and future.

*Fully Diversified Portfolio:
Dimensional US Adjusted Market 2 Index: 30%
DFA Equally Weighted Emerging Markets Index: 5%
Five-Year US Treasury Notes: 40%
Dimensional International Market Index: 25%
Rebalanced annually

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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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