The 4 x 14 Retirement Portfolio (TM)

 

©2011 Integrity Financial Planning. All rights reserved. http://www.integrityplanner.com

A Hassle-Free, Well-Balanced Investment Approach for: 

          IRA Investors

          401k and 403b Savers

          Retirees Who Need Retirement Income

The 4 × 14 Retirement Portfolio™

One of the most important decisions to make as a retirement investor is the mix of different types of assets (also known as “asset allocation”) in your retirement accounts. The purpose of this short paper is to introduce you to an asset mix called the 4  × 14 Portfolio™.

In simple terms, this portfolio invests in 4 major asset categories: stocks, fixed income (aka bonds), real estate and natural resources. The following figure shows an approximate percentage breakdown for each of the 4 major asset classes. These 4 major asset categories are then subdivided into 14 sub-classes, hence the name of the model: the 4 × 14 Portfolio™.

Investing in multiple asset classes can result in higher growth rates and lower downside potential, if the asset classes are combined in a way so that the individual sub-asset classes are not overly tied together in terms of performance. For example, rising inflation rates may lead to poor investment results for the fixed income class, but at the same time may result in better performance for real estate investments as property values rise with inflation.

The goal of the 4 × 14 Portfolio™ is to mix together many sub-asset classes that are not locked together arm-in-arm. For any given period of time, some of the sub-asset classes will generally be up, and some will be down. Hopefully over time the “ups” will be greater than the “downs.” Looking at actual historical index results over the last decade provides some insights into past performance. But of course, past performance is no guarantee of future results.

The 4 × 14 Portfolio: Upside Growth, Some Downside Protection

The following graphic shows the actual historical performance of the 4 × 14 Portfolio™ based on index returns, assuming a $100,000 investment in January 2000 with annual rebalancing. This performance could be replicated with a selection of investment vehicles such as index mutual funds and exchange-traded funds, though investment costs would result in somewhat lower overall performance. Nonetheless, this diagram illustrates how the 4 × 14 Portfolio™ would have performed through two bear markets, the first in 2001-2002 and the second in 2008.

Note the portfolio held up well in the 2001-2002 bear market for stocks, but it did experience a 28% drop in the 2008 bear market for nearly all asset classes. In that year, only the fixed income asset class enjoyed positive returns. Fortunately the 4 × 14 Portfolio™ more than recovered within the next two years, surpassing its previous high-water mark in 2007. For the entire 11-year period, the portfolio generated an 8.11% compound annual return—not bad, considering it went through two bear markets and two recessions.

Does Diversification Always Work?

The following image demonstrates why it is nearly always wise to have your retirement savings “eggs” in more than one basket. This illustration shows how four different portfolios, based on actual historical index performance, would have fared over the 11-year period from 2000 to 2010.

 The all-stock portfolio had the poorest overall performance, leading to the oft-quoted but truly misnamed “lost decade” for retirement investors. Note that the 1/3rd US Stocks/Bonds/Real Estate portfolio generated the best returns in the first half of the decade, only to be eclipsed by the 4 × 14 Portfolio™ by the end of 2010. In 2008, the 50/50 US Stocks/Bonds portfolio incurred the least amount of principal damage.

For the 11-year period, the compound annual rates of return were: 0.91% for the all-stock portfolio; 4.28% for the 50/50 portfolio; 7.08% for the three-asset class portfolio; and 8.11% for the 4 × 14 Portfolio™. The next diagram compares the 2010 ending values for each portfolio.

How Would the 4 × 14 Portfolio™ Fare for a Retiree Taking Withdrawals?

The prior examples all assume a retirement investor is in saving mode. As demonstrated, investing in multiple asset classes generally led to superior long-term performance. But does diversification also make sense when withdrawals are being made from a portfolio?

The following chart indicates a multi-asset mix like that found in the 4 × 14 Portfolio™ also makes sense for retirees who need to generate income from their retirement savings. This example covers the same 11-year period from 2000 to 2010, starting with a $100,000 investment, annual year-end rebalancing (for calculation simplicity) and a 5% withdrawal (also for simplicity’s sake) made at the end of each year. No adjustment is made for inflation to the withdrawal rate, as several of the sub-asset classes are considered good long-term inflation hedges capable of keeping up with or even exceeding the rate of inflation. In real life, all of these variables (when to rebalance, withdrawal percentage rates, etc.) should be adjusted for a retiree’s unique situation.

Over the 11-year period, the 4 × 14 Portfolio™ generated more than $68,000 in withdrawals and ended 2010 with a principal balance $34,000 greater than the initial investment. And this performance occurred in spite of two bear markets. Nonetheless, the withdrawal amount did fall by 31% in 2008 at the height of the bear market/recession, though in dollar terms it was roughly the same as the first year in the entire period.

No portfolio works perfectly in every investment environment. Fortunately the withdrawal amount grew quickly during the next two years, reaching over $7,000 by 2010. For the 11 years, the 4 × 14 Portfolio™ in withdrawal mode generated a 2.75% compound annual growth rate.

This distribution-mode example points out very clearly the impact of taking withdrawals from a portfolio versus simply “buying and holding.” In saving mode, the 4 × 14 Portfolio™ was worth about $236,000 by the end of 2010. In distribution mode, the portfolio was worth $100,000 less over the same time period, though it did generate almost $70,000 worth of withdrawals. Retirees who are taking income from their retirement savings would be wise to employ a multi-asset mix in their portfolios. The following figure illustrates the wisdom of this approach.

Once again, the single-asset all-stock portfolio performed the worst and generated the smallest withdrawal amount for 2010. By adding more asset classes, the more diversified portfolios generated higher-ending principal balances and greater withdrawal amounts. Diversification does indeed make sense for retirees taking distributions from their retirement portfolios as well as workers saving for retirement.

If you would like further information about building the 4 × 14 Portfolio™ for your retirement accounts, or other concepts to help you maximize your retirement readiness, please contact Mike Wilson of Integrity Financial Planning at 260-829-6319. You can also reach Mike online at http://www.integrityplanner.com or via e-mail at mike@integrityplanner.com.

©2011 Integrity Financial Planning. All rights reserved. http://www.integrityplanner.com

Advertisements

About Mike Wilson

Michael L. Wilson, MBA, CFP®, CRC®, is the owner of Integrity Financial Planning. Prior to founding Integrity in 1998, he worked for two years as a faculty member at the College for Financial Planning in Denver, training other financial advisors. Mike has 10 years of experience in the mutual fund industry, having worked with Fidelity Investments and Invesco Mutual Funds. He holds an MBA in Finance from Baylor University. Learn more about his work at www.integrityplanner.com.
This entry was posted in Retirement Wealth and tagged , , , , , , , . Bookmark the permalink.

One Response to The 4 x 14 Retirement Portfolio (TM)

  1. Pingback: Freakonomics » New Freakonomics Radio Podcast: “The Folly of Prediction” | Maximizing Retirement Readiness

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s