So, here is how the portfolio performed over the years:

As you can see, 2008 was a tough year. The entire portfolio was down 16.75% that year. The domestic equity portion lost 36.99%, the international equity portion was down 40.50%, and the fixed income portion was up 4.89%.

I’ll provide a PDF of the year-by-year portfolios in a follow-up.

I have monthly total returns for the S&P 500 (S&P 90 prior to February 1957) going all the way back to January 1926. However, I only have the Barclay’s Aggregate Bond Index (formerly known as the Lehman Aggregate Bond Index) going back to January 1991.

Anyhow…

I thought it would be interesting to look at different portfolio allocations and see how they would have performed from 1991 through 2011. I assumed a beginng balance of $100,000 and annual rebalancing at the end of each year. I started out with 100% stocks and no bonds and then decreased the stock allocation by 5% while increasing the bond allocation 5% until I got to 100% bonds. You can download a PDF of my findings here: S&P with Bonds (1991 – 2011).

What I found interesting was the portfolio that brought the biggest balance at the end of 2011 was the 95% stocks/5% bonds. Not only that, it delivered a better return with slightly less volatility—as measured by the monthly standard deviation.

Another interesting finding was how well the 70% stocks/30% bonds portfolio did. Take a look at the charts for the 100% stock portfolio and the 70/30 portfolio:

As you can tell from the charts, the 70/30 had significantly less volatility than the 100% stock portfolio. It captured 97% of the all stock allocation but only experienced 70% of volatility* (again, measured by monthly standard deviation). It seems like a reasonable trade-off to me.

But, that’s not the only way to look at it.

Another way to look at it is to look at potential retirement income. For instance, let’s say you want to withdraw 4% of your account balance upon retirement. Here are the different income amounts based on the ending values of the portfolios:

It’s important to note that past returns aren’t predictors of future results. That’s something to keep in mind when deciding on how to allocate your portfolio. I tend to be more on the aggressive side with our retirement portfolio but these findings are making me rethink my strategy. That said, I can accept more volatility now for hopefully higher income at retirement.

Thoughts?

*To arrive at that number, I simply divided the monthly standard deviation for the 70/30 portfolio by the standard deviation for the 100% stock portfolio.

Notice that I added a new column at the end for the weighted average return for all ten asset classes (assuming a ten percent stake in each asset class rebalanced monthly).

As you can see, June wasn’t a good month (click on the graphic to view a PDF version).

NOTE: I discovered a transposing error in last month’s numbers. I have made the correction on this month’s numbers.

…according to Vanguard: In four out of seven bear markets since January 1973, the Dow Jones U.S. Total Stock Market Index beat the average actively managed fund. The two bears in which many funds did better than the index were both in the 1980s.

This graphic included in the article doesn’t do much for the active management side of the argument (the graphic is slightly confusing because it doesn’t make clear that the bars represent the percentage of active managers that beat the Dow Jones U.S. Total Stock Market Index. You may click on the graphic to see a larger version):

This is all stuff we already knew but it’s interesting to read about it in a financial planning magazine.

Next, I’ll look at the performance of the indexes vs. their growth and value sub-indexes. Stay tuned…

As you can see, the results looks pretty good—especially when you consider the fact that one-third of the portfolio is in bonds and cash. Dr. Israelsen gives much more detailed information in his book, which I reviewed here. I was also able to conduct an interview with Dr. Israelsen. I’m going to keep tracking this portfolio. I’ll rebalance back to the orginal allocation and post updates monthly or quarterly (as time permits).

*Affiliate Link

NOTES: This portfolio assumes $1,000,000 initial investment with a 5% income withdrawal on December 31, 2009 for a net investment of $950,000. The portfolio also does not include trading costs.

The Vanguard REIT Index ETF is up over 24% year-to-date and now makes up 9.49% of the total portfolio.

I’ll have an update for the “7 Twelve” portfolio today.

I want to focus on his trick #2 – “average annual” return. According to Roth:

If you actually possess the attention span to slog through the 373 page disclosure document, you would clearly see on page 189 that the term “average annual return” is defined as 1/12 of the first month plus 1/12 of the second month, etc. This translates to getting an expected tad over half the total annual return. Depending on the timing of the market increase, this could be either more or less than half. In this example, it yields about 54% of the total increase of the index.

I asked Allan for clarification on exactly how this works and this is what he said:

“You’d have to use 1/12 of the YTD returns. The 12th month would count the full year’s return but it would only weight 1/12 of the amount.”

Allan did not provide me with the name of this particular annuity so I don’t know all the details. He did, however, tell me that this particular EIA will not allow the account to have a negative return over the year. It’s important to note that this is over the year and not on a month-to-month basis.

In order to see how this would work in the real world, I used the 2009 monthly returns for the S&P 500 Index (NOTE: These are index returns and NOT total returns, which would include dividends). Here is what I found:

In case it’s not clear, the YTD column is what’s used to calculate how the account is credited. Each of the months are credited 1/12th of whatever the YTD return is on the index. Then, those amounts are summed to get the return for the year. So, for 2009, while the index returned 23.45% (not including dividends), this annuity was credited with a 5.01% return (BEFORE FEES!). If you take off the 2% for fees, the return is down to around 3.01%.

Who in the world would go for such a product? Clearly this particular product favors the insurance company. They get the dividends and the 2% management expense. If the insurance company invests in the underlying index, they get the spread in returns (23.45 – 5.01).

I would avoid these products. They are complicated and very different so that it’s very hard to make an apples-to-apples comparison. I would stick to a fixed immediate annuity or possibly a very low cost variable annuity. If you are enticed by a an equity-index sales pitch, do yourself a favor and get a second opinion BEFORE you sign any documents.