A Hassle-Free, Well-Balanced Investment Strategy for:
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 an innovative strategic asset blend called the 4 × 14 Portfolio™.
In simple terms, this well-balanced portfolio invests in 4 major asset categories: stocks, fixed income (bonds, CDs, money market funds), real estate (including income-producing property like shopping centers and office complexes) and natural resources (commodities, timber, steel, aluminum, etc.). The following figure shows an approximate breakdown for each of the 4 major asset classes, which are then subdivided into a total of 14 sub-classes, hence the name of the model: the 4 × 14 Portfolio™.
Long-term investing in multiple asset classes can result in higher growth rates and lower downside potential, if the individual sub-asset class returns are not overly tied together. 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 natural resources as commodity prices rise with inflation.
The goal of the 4 × 14 Portfolio™ is to efficiently 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 or so 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; their costs might lower the portfolio’s performance shown here by about ½ of 1%. Nonetheless, this diagram illustrates how the 4 × 14 Portfolio™ would have performed through two bear markets, in 2001-2002 and 2008.
Note the portfolio held up well in the 2001-2002 bear market for stocks, but it did fall by 28% 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 three years, surpassing its previous high-water mark in 2007. For the entire 13-year period, the portfolio generated a 7.73% 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 13-year period from 2000 to 2012.
The all-stock portfolio (Russell 1000) had the poorest overall performance, leading to the oft-quoted but truly misnamed “lost decade” for 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 2012. In the 2008 bear market, the 50/50 US Stocks/Bonds portfolio incurred the least amount of principal damage.
For the 13-year period, the compound annual rates of return were: 2.07% for the all-stock portfolio; 4.76% for the 50/50 portfolio; 7.46% for the three-asset class portfolio; and 7.73% for the 4 × 14 Portfolio™. The next diagram compares the 2012 ending values for each portfolio over the 13-year period.
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 savings?
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 13-year period from 2000 to 2012, starting with a $100,000 investment, annual year-end rebalancing (for calculation simplicity) and a 5% withdrawal made at the end of each year (also for simplicity’s sake). 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 13-year period, the 4 × 14 Portfolio™ generated almost $82,000 in withdrawals and ended 2012 with a principal balance $35,000 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.
Clearly, no portfolio works perfectly in every investment environment. Fortunately the withdrawal amount grew quickly after 2008, reaching over $7,100 by 2012. For the 13 years, the 4 × 14 Portfolio™ in withdrawal mode generated a 2.35% 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” as a saver. In saving mode, the 4 × 14 Portfolio™ was worth about $263,000 by the end of 2012. In distribution mode, the portfolio was worth $128,000 less over the same time period, though it did generate almost $82,000 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 in 2012. By adding more asset classes, the more diversified portfolios generated higher-ending principal balances and greater withdrawal amounts. The simple truth is, 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 strategies to 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 email@example.com.