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Building a Portfolio For Retirement
By JLP | March 12, 2008
Investing during retirement is a tricky business. Not only do you have to consider yourself a long-term investor, you also live off your assets, which makes you a short-term investor. If you lean too much to one side or the other, you run the risk of jeapordizing your retirement. The key to investing in retirement is to limit volatility. Sure, you can purchase an annuity but they can be costly and can limit your flexibility. Is there a better way?
Back in January I wrote about a short post on reducing a portfolio’s volatility by equally allocating seven asset classes in a portfolio. That post was in reference to a Wall Street Journal article I had read on the topic, which highlighted the work of Craig Israelsen, a professor at Brigham Young University. I contacted Dr. Israelsen and asked him a few questions about his work. He was kind enough to send me a copy of a MUST-READ article he had written that was published in the Nov/Dec 2007 issue of the Journal of Indexes.
I then put together another model portfolio based on Dr. Israelsen’s work using exchange-traded funds. I assumed a beginning value of $1 million, with a 5% withdrawal for income, which put the beginning portfolio value at $950,000. I then allocated 14.25% to six of the asset classes and 14.5% to the cash class. Here’s what I came up with (you can click on the graphic to see a larger version):
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Not too bad considering what market is doing so far this year. Of course there’s a lot more to consider than just two months of returns. That’s why I urge you to read Dr. Israelsen’s article. If you have any questions, leave a comment and I’ll see if I can get Dr. Israelsen to answer them.
Topics: Investing, Retirement Planning | 14 Comments »
March 12th, 2008 at 2:49 pm
Could you talk a little more about annuities? Who do so many people go for them?
March 12th, 2008 at 5:37 pm
I’ve been meaning to ask about those tables… they make my eyes hurt.
They look like something Edward Tufte might use as an example of “excess ink and zebra tables.”
Desaturating the colors and toning down the contrast might go a long way to making them somewhat readable.
March 12th, 2008 at 6:26 pm
lorax,
Point taken. Is it better now?
March 13th, 2008 at 1:56 am
There’s one camp that say no commodities as they have an overall real return of 0%. And then there’s another camp that says commodities are portfolio insurance against inflation.
After this past year, I’m firmly in the 2nd camp now. I started diversifying my 100% stock portfolio late 2006 and picked up both commodities and TIPS. During the past year of rate cut after rate cut (Fed inflating money supply), TIPS have done pretty well with inflation on the rise — about +12%. But my commodity funds & ETFs have done even better — +30% in the past few months. Just slicing off a bit does wonders for an overall portfolio during times of unexpected inflation.
March 13th, 2008 at 7:53 am
No discussion of allocation is complete without at least one commenter, me, hammering on the idea of rebalancing. You could almost miss that word in the article as it is quite underplayed (even appearing once in a parenthetical like this). Those portfolios are all rebalanced once a year.
Bernstein’s “Intelligent Asset Allocator” does a great job explaining the point. To summarize generically, if you aren’t rebalancing your portfolio on a regular basis, at least every 2-3 years, then you are not getting the proper risk-reducing benefit from non-correlated asset classes.
Rebalancing is way more important than actual allocation. If your allocation is reasonable then rebalancing will make the most of it. If you don’t rebalance, it doesn’t matter if your (original) allocation is optimal because you won’t benefit appropriately from it.
March 13th, 2008 at 4:26 pm
Great Point Don!
I would still argue that total asset allocation is just as important as pure re-balancing. Re-balancing allows you to maintain a balanced portfolio given market changes, while pure asset allocation changes allow you to maintain a portfolio that fits lifestyle changes.
March 13th, 2008 at 6:40 pm
Much better.
March 13th, 2008 at 8:27 pm
So many retirees on BoomerMingle.com are discussing the problem on annuities, want to join?
BTW, BoomerMingle is a niche dating site caters to singles in my age group.
March 16th, 2008 at 6:43 am
DISCLAIMER! First, I am not any type of an expert by any means, this is just how I understand annuities. And, I’m still learning all about this whole investing/retirement stuff. (anyone that finds errors in this, please feel free to point out where I am wrong, if i am.)
This is for Nikhila… Annuities
Annuities are basically a “savings account” or investing account with an insurance company. There are 2 types. Fixed annuities, and variable annuities.
Fixed annuities include one or more of things like CD’s, money market funds, bonds and T-bills, etc.
Variable annuities usually involve one or more growth stock mutual fund(s) inside of the annuity.
All an annuity basically is, is a deal between you, the insurance company and the IRS to determine how that savings/investment deal is handled for taxes. Annuities grow tax deferred and you pay taxes on the money when you take it out in retirement.
Now annuities arent evil, but I think alot of people get in to them at the wrong time and under the wrong circumstances because of sales pressure from the insurance company to buy them (especially as part of a Life Insurance Policy).
Since the annuity (tax shelter) itself has a fee, plus the mutual fund company’s fees and other fees associated with the investments themselves, annuities are the more expensive tax shelters for retirement, compared to 401K type plans, IRA’s (including ROTH), and other options. Most of the other options are usually really low cost or dont cost anything, and you’ll do better in those because you aint getting eaten up by fees.
I would do annuities only after you have maxed out all other tax advantaged retirement options and still have money to throw at retirement savings.. After annuities are maxed out.. your on to taxed accounts.
Again this is just my understanding of this.. anyone feel to make corrections, please feel free.
March 16th, 2008 at 12:01 pm
Thanks for this post!
I have written about both the Grangaard Strategy (Paul Grangaard)and Worry-Free Investing (Zvi Bodie) – probably the two best ‘alternative’retirement strategies that I have come across. The better (but more hands on) strategy is a combined portfolio of direct real-estate investment + a few well-selected stocks.
The weakest strategy is a diversified portfolio through managed funds … you can only safely withdraw 2.5% – 3.5% of your portfolio every year IF you want to be at least 90% certain that your money will last as long as you do!
March 16th, 2008 at 8:04 pm
I’ve been writing for a company who gives you a free look into what they can do for clients and their finances to help them manage their debt and start saving for the future. The website is http://www.debtreliefsystems.net . It looks like a great offer for anyone struggling with their debt load or looking for the best ways to finance their future.
March 17th, 2008 at 5:16 am
Also, why GSG for commodities? GSG is an exchange traded note, which relies on backing by the issuer (Barclay’s). As we’ve seen, it’s not necessarily a good idea to rely on a good credit rating, no matter if it’s really good right now. Maybe an ETF would be better.
May 10th, 2008 at 9:21 pm
Asset allocation represents almost 90% of returns, this according to David Swensen. Rebalancing and other techniques to tweak portfolios constitute the rest of the 10%.
June 10th, 2008 at 4:06 pm
“Dr. Israelsen’s article” points to wrong link, can u pls fix it?
thanks.