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2005 Update: Real-Life Retiree Investment Returns

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2005 Update
Real-Life Retiree Investment Returns


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This article was first posted on July 1, 2002, updated on March 1, 2005.

Looking back over the past ten years, I thought it might be interesting to see how some popular investment strategies have fared since I quit work in November 1994. During that time, we've seen a five year bull market followed by a three year bear market. Over the past year the stock market has staged a significant recovery. The good news is that anyone with a reasonably diversified portfolio did just fine. It's not bad news, but, of course, some strategies performed better than others. The chart below shows the results for a $100,000 starting balance and a 4% of assets initial withdrawal indexed annually for inflation. Vanguard index funds are used whenever possible in this analysis. If you want to check the calculations, you can download the Excel spreadsheet, click here.

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All of portfolios increased in value in 2003. Despite historically low interest rates, even 100% fixed income portoflio showed a slight gain, though it is still in last place over the nine-year time frame.

Real-Life Retiree Returns
Dec 31 Portfolio Values, $100,000 starting balance,
4% initial inflation-adjusted withdrawal rate
Year 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
75% S&P500/
25% FI
$100,000 $125,756 $144,002 $176,904 $212,405 $242,766 $226,770 $206,254 $170,402 $202,477 $202,477 N/A
One Fund
60%/40%
$100,000 $123,494 $136,040 $161,119 $184,810 $204,995 $196,412 $185,982 $163,993 $190,782 $190,782 N/A
100% Fixed Income $100,000 $107,965 $108,851 $111,824 $114,537 $113,875 $118,237 $122,642 $123,916 $123,925 $123,925 N/A
MPT Portfolio $100,000 $115,671 $127,214 $141,641 $146,591 $162,437 $161,756 $156,527 $141,155 $169,045 $169,045 N/A
Warren Buffett Portfolio $100,000 $140,120 $144,022 $178,711 $245,434 $207,327 $247,230 $258,910 $249,963 $276,444 $276,444 N/A
Harry Dent Portfolio $100,000 $131,349 $155,859 $180,948 $246,282 $298,324 $342,689 $307,762 $257,469 $330,648 $330,648 N/A
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1. Retire Early Safe Withdrawal Study Portfolio (S&P500/Fixed Income)

Most of the various safe withdrawal studies done over the years assume some combination of an S&P500 index fund and fixed income assets. While the Retire Early study used 3-month commercial paper for the fixed income allocation, most retirees only keep one year's worth of expenses in a money market fund and the balance of their fixed income allocation in a ladder of CDs or bonds. To more closely model retirees' actual practice, an allocation of 4% of assets to Vanguard's Prime Reserve Money Market Fund (VMMXX) and 21% to Vanguard's Short-Term Corporate Bond Fund (VFSTX) was used for the 25% fixed income allocation.

Retire Early Safe Withdrawal Study Portfolio
75% S&P500, 25% Fixed Income, rebalanced annually

75% VFINX, 21% VFSTX, 4% VMMXX
Year 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Dec 31 Balance $100,000 $125,756 $144,002 $176,904 $212,405 $242,766 $226,770 $206,254 $170,402 $202,477 N/A
Annual Withdrawal (1) N/A $4,000 $4,109 $4,234 $4,301 $4,373 $4,492 $4,660 $4,713 $4,836 $4,929
Percent of assets (2) N/A 4.00% 3.27% 2.94% 2.43% 2.06% 1.85% 2.05% 2.29% 2.84% 2.43%
Years in fixed income (3) N/A 6.25 7.65 8.50 10.28 12.14 13.51 12.17 10.94 8.81 10.27
Notes

(1)....Dollar value of 4% of assets initial withdrawal indexed to the CPI-U in future years.
(2)....Annual withdrawal as a percent of previous year's Dec 31 balance.
(3)....Years' worth of annual withdrawals in fixed income assets (based on previous year's Dec 31 balance.)

Retirees following this approach over the past 9 years have been generally pleased with the results. Even after taking nine years of inflation-adjusted withdrawals, the account balance has more than doubled of Dec 31, 2002 to $202,477 from its $100,000 initial value. The 25% fixed income allocation has also grown from 6.25 years' worth of annual withdrawals to 10.27. The Jan 2004 withdrawal of $4,929 amounted to just 2.43% of assets.



2. One Fund Portfolio (Vanguard Balanced Index Fund (VBINX))

If even annual rebalancing of your retirement portfolio sounds like too much of a job, Vanguard's Balanced Index Fund may be a solution. The fund maintains a 60% allocation to the Wilshire 5000 Index and 40% to the Lehman Aggregate Bond Market Index. The expense ratio is 0.22%.

One Fund Portfolio (Vanguard Balanced Index Fund (VBINX)
60% S&P500, 40% Fixed Income, rebalanced continuously

100% VBINX
Year 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Dec 31 Balance $100,000 $123,494 $136,040 $161,119 $184,810 $204,995 $196,412 $185,982 $163,993 $190,782 N/A
Annual Withdrawal (1) N/A $4,000 $4,109 $4,234 $4,301 $4,373 $4,492 $4,660 $4,713 $4,836 $4,929
Percent of assets (2) N/A 4.00% 3.33% 3.11% 2.67% 2.37% 2.19% 2.37% 2.53% 2.95% 2.58%
Years in fixed income (3) N/A 10.00 12.02 12.85 14.99 16.91 18.25 16.86 15.78 13.57 15.48
Notes

(1)....Dollar value of 4% of assets initial withdrawal indexed to the CPI-U in future years.
(2)....Annual withdrawal as a percent of previous year's Dec 31 balance.
(3)....Years' worth of annual withdrawals in fixed income assets (based on previous year's Dec 31 balance.)

Retirees following this approach over the past 9 years have been generally pleased with the results. Even after taking nine years of inflation-adjusted withdrawals, the account balance is up over 90% as of Dec 31, 2003 to $190,782 from its $100,000 initial value. The 40% fixed income allocation has also grown from 10.00 years' worth of annual withdrawals to 15.48. The Jan 2004 withdrawal of $4,929 amounted to just 2.58% of assets.



3. 100% Fixed Income

Some retirees just can't stomach the ups and downs of the stock market and prefer to keep all their retirement assets in fixed income securities. Few experts advise this, but folks do it anyway. Luckily, inflation has been moderate over the past nine years and a retiree making annual withdrawals from a portfolio has at least kept pace with inflation -- the January 2004 withdrawal amounted to 3.98% of assets. An allocation of 4% to Vanguard's Prime Reserve Money Market Fund (VMMXX) and 96% to Vanguard's Short-Term Corporate Bond Fund (VFSTX) was used for this all fixed income approach.

100% Fixed Income
100% Fixed Income, rebalanced annually

96% VFSTX, 4% VMMXX
Year 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Dec 31 Balance $100,000 $107,965 $108,851 $111,824 $114,537 $113,875 $118,237 $122,642 $123,916 $123,925 N/A
Annual Withdrawal (1) N/A $4,000 $4,109 $4,234 $4,301 $4,373 $4,492 $4,660 $4,713 $4,836 $4,929
Percent of assets (2) N/A 4.00% 3.81% 3.89% 3.85% 3.82% 3.94% 3.94% 3.84% 3.90% 3.98%
Years in fixed income (3) N/A 25.00 26.27 25.71 26.00 26.19 25.35 25.37 26.02 25.63 25.14
Notes

(1)....Dollar value of 4% of assets initial withdrawal indexed to the CPI-U in future years.
(2)....Annual withdrawal as a percent of previous year's Dec 31 balance.
(3)....Years' worth of annual withdrawals in fixed income assets (based on previous year's Dec 31 balance.)

Two prominent early retirees have followed the 100% fixed income approach. Your Money Or Your Life author Joe Dominguez invested in only US Treasury securities when he retired in 1969 at age 31 and continued to champion that approach up until his death in 1997. Dominguez retired in 1969 with a $100,000 portfolio and $7,000 per year in living expenses. An August 1996 Kiplinger's Personal Finance Magazine article revealed that Dominguez was then living on about $13,000 per year. To keep pace with inflation, $7,000 in 1969 would need to grow to $30,360 by 1996 to maintain the same purchasing power. Dominguez managed this loss of spending power with unusual living arrangements (he lived in a group home with about 30 other people) and a lot of composting and the washing and reusing of tin foil and wax paper -- a strategy that few early retirees would tolerate.

Paul Terhorst, author of Cashing in on the American Dream: Retire at 35 limited his investments to a laddered portfolio of FDIC-insured Certificates of Deposit (CDs) when he retired in 1984. His web site ( http://www.geocities.com/TheTropics/Shores/5315/ ) reveals he holds "a more traditional portfolio heavily weighted with low-cost [equity] index funds" today.


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4. Modern Portfolio Theory (Asset Allocation)

Modern Portfolio Theory (MPT) holds that wide diversification among different asset classes increases investment returns. It was first advanced in the early 1950's by Princeton University Professor Harry M. Markowitz. He won the Nobel Prize in Economics in 1990 along with William F. Sharpe and Merton Miller for his work in portfolio diversification and investment returns. In recent years, author William J. Bernstein has popularized these concepts in his book The Intelligent Asset Allocator and on his web site http://www.efficientfrontier.com.

I studied MPT back in the late 1970's when I was getting my MBA and agree that wide diversification reduces the volatility of a portfolio. I'm just not completely convinced it actually increases investment returns over the long run -- especially if you are willing to accept some risk. Diversification is good, but I side with Vanguard's Jack Bogle and Warren Buffett that over-diversification really isn't a virtue. (Both Bogle and Buffett argue that there is little need for a US investor to hold foreign securities.)

To illustrate an MPT portfolio the nine-asset class Bernstein-inspired portfolio described in a December 2000 Smart Money magazine article was chosen. This portfolio covers the gamut from large cap to small cap US stocks, international equites, emerging markets, REITs, and short term bonds. The 40% allocation to Vanguard's Short-Term Corporate Bond Fund (VFSTX) was changed to 36% VFSTX and 4% Prime Money Market Fund (VMMXX) to provide the one year's worth of expenses in a money market fund that most retirees maintain.

Asset Allocation (MPT)
60% Stock/40% Fixed Income, rebalanced annually

15% VTSMX, 10% VISVX, 10% VIVAX, 5% VEIEX, 5% VEURX, 5% VPACX, 5% VGSIX, 5% NAESX
36% VFSTX, 4% VMMXX
Year 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Dec 31 Balance $100,000 $115,671 $127,214 $141,641 $146,591 $162,437 $161,756 $156,527 $141,155 $169,045 N/A
Annual Withdrawal (1) N/A $4,000 $4,109 $4,234 $4,301 $4,373 $4,492 $4,660 $4,713 $4,836 $4,929
Percent of assets (2) N/A 4.00% 3.55% 3.33% 3.04% 2.98% 2.77% 2.88% 3.00% 3.43% 2.92%
Years in fixed income (3) N/A 10.00 11.26 12.02 13.17 13.41 14.46 13.88 13.32 11.68 13.72
Notes

(1)....Dollar value of 4% of assets initial withdrawal indexed to the CPI-U in future years.
(2)....Annual withdrawal as a percent of previous year's Dec 31 balance.
(3)....Years' worth of annual withdrawals in fixed income assets (based on previous year's Dec 31 balance.)

While the MPT portfolio value has trailed the simple S&P500/fixed income portfolio (No. 1 above) by some 16% as of Dec 31, 2003, advocates of this approach like its reduced volatility and sterling academic recommendations. Which brings us to an important investing truism -- it's OK to under perform as long as you're pleased with the results and proud of what you are doing.


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Concentrated Portfolios

The efficient market theorists don't like it, and warn that it's too risky, but many investors eschew index funds and hold individual stocks or concentrate on one or more industry sectors. Most of the research I've seen shows that no more than 20% of the people who hold individual stocks out perform the S&P500. If you're a member of this minority, obviously you're pleased. Here's a couple of concentrated portfolios I've followed over the years.

5. Warren Buffett Portfolio (BRKa/Fixed Income)

Warren Buffett, Chairman and CEO of Berkshire Hathaway is the second richest man in the United States after Bill Gates. It's even more noteable that he's one of the few members of the Forbes 400 who got there by investing in stocks rather than founding a successful business or inheriting his fortune. His investment strategy is to buy and hold positions in a few companies and watch them very carefully. Two stocks (American Express and Coca-Cola) make up about half the value of Berkshire's $35.3 billion stock portfolio. The Top 7 stocks comprise more than 80% of the portfolio.

Berkshire Hathaway's Investment Portfolio (as of Dec. 31, 2003)
Shares Company Cost Market
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151,610,700 American Express Company $ 1,470 $ 7,312
200,000,000 The Coca-Cola Company 1,299 10,150
96,000,000 The Gillette Company 600 3,526
2,338,961,000 PetroChina Company Limited 488 1,340
24,000,000 Moody's Corporation 499 1,453
1,727,765 The Washington Post Company 11 1,367
56,448,380 Wells Fargo & Company 463 3,324
. Others 3,685 6,815
. Total Common Stocks $8,515 $35,287

For the purposes of a retirement portfolio, a mix of 75% Berkshire Hathaway stock, 4% money market fund and 21% short-term corporate bond fund was chosen for the example below. Through December 31, 2003, the value of the Warren Buffet portfolio exceeded the S&P500/fixed income portfolio by 37%.

Warren Buffett Portfolio
75% Stock/25% Fixed Income, rebalanced annually

75% BRKa
21% VFSTX, 4% VMMXX
Year 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Dec 31 Balance $100,000 $140,120 $144,022 $178,711 $245,434 $207,327 $247,230 $258,910 $249,963 $276,444 N/A
Annual Withdrawal (1) N/A $4,000 $4,109 $4,234 $4,301 $4,373 $4,492 $4,660 $4,713 $4,836 $4,929
Percent of assets (2) N/A 4.00% 2.93% 2.94% 2.41% 1.78% 2.17% 1.88% 1.82% 1.93% 1.78%
Years in fixed income (3) N/A 6.25 8.52 8.50 10.39 14.30 11.54 13.26 13.73 12.92 14.02
Notes

(1)....Dollar value of 4% of assets initial withdrawal indexed to the CPI-U in future years.
(2)....Annual withdrawal as a percent of previous year's Dec 31 balance.
(3)....Years' worth of annual withdrawals in fixed income assets (based on previous year's Dec 31 balance.)

If you want to learn more about how Mr. Buffett selects stocks, one good book on the subject is Buffettology by his daughter-in-law Mary Buffett .


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6. Harry Dent Portfolio

Harry Dent made perhaps the most prescient forecast of the great bull market of the 1990's in his 1993 book The Great Boom Ahead. His theory of demographic investing sees the Dow Jones average hitting 41,000 by the year 2008. The chart below summarizes Dent's long-term forecast.

Dent favors three sectors of the economy during the 1982-2008 boom: technology, health care, and financial services. More troubling is the 12-14 year long recession/depression from 2009 to 2022. The deflation during that period will make long-term US Treasury securities the investment of choice.

Three sector funds were used to build the Harry Dent portfolio below. The Vanguard Health Care Fund (VGHCX) was chosen for its low expense ratio. Since Vanguard doesn't offer similiar specialized funds in other areas, the Fidelity Computer Technology (FDCPX) and Financial Services (FIDSX) sector funds are a convenient choice though personally I'd gag at paying the 3% front-end load. (Note: Fidelity recently stopped changing sales loads on its funds.) My preference would be the purchase of a LTB&H basket of stocks in each industry sector.

Harry Dent Portfolio
75% Stock/25% Fixed Income, rebalanced annually

25% FIDSX, 25% FDCPX, 25% VGHCX
21% VFSTX, 4% VMMXX
Year 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Dec 31 Balance $100,000 $131,349 $155,859 $180,948 $246,282 $298,324 $342,689 $307,762 $257,469 $330,648 N/A
Annual Withdrawal (1) N/A $4,000 $4,109 $4,234 $4,301 $4,373 $4,492 $4,660 $4,713 $4,836 $4,929
Percent of assets (2) N/A 4.00% 3.13% 2.72% 2.38% 1.78% 1.51% 1.36% 1.53% 1.88% 1.49%
Years in fixed income (3) N/A 6.25 7.99 9.20 10.52 14.08 16.60 18.38 16.32 13.31 16.77
Notes

(1)....Dollar value of 4% of assets initial withdrawal indexed to the CPI-U in future years.
(2)....Annual withdrawal as a percent of previous year's Dec 31 balance.
(3)....Years' worth of annual withdrawals in fixed income assets (based on previous year's Dec 31 balance.)

Harry Dent has written three books on demographic investing. The first book, The Great Boom Ahead is the best. Like most sequels, the second and third installments lack the impact of the original work.


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How about some losing portfolios?

There's no shortage of losing strategies you could have employed over the past nine years. Market timing, day trading, Internet stocks with no record of earnings, etc. likely would have lost you money unless you were one of the fortunate few who sold out at the top. Retirees who see the value in holding at least 5 years' worth of expenses in cash and CDs and maintain some level of diversification in their portfolios would have rejected most of these losing investment approaches on principle alone.

What if you retired in January 2000?

If you happened to retire in January 2000, just before the stock market peak, the three year long bear market took it's toll. Only the 100% fixed income and Warren Buffett portfolios exceed their $100,000 starting balance after four years of annual retirement withdrawals. The worst performer was the 75% S&P500/25% fixed income portfolio. Oddly, the "risky" Harry Dent portfolio is within $1,000 of the extremely well-diversified MPT portfolio after four years. The chart below illustrates the results.

What to conclude from these results? There's a reason Warren Buffett is regarded as the most successful stock market investor of all time.

[Chart]


Real-Life Retiree Returns
Dec 31 Portfolio Values, $100,000 starting balance,
4% initial inflation-adjusted withdrawal rate
Year 1999 2000 2001 2002 2003 2004
Annual Withdrawal N/A $4,000 $4,149 $4,197 $4,306 $4,389
75% S&P500/25% FI $100,000 $91,365 $80,990 $64,928 $74,137 N/A
One Fund 60%/40% $100,000 $94,042 $87,178 $75,081 $84,838 N/A
100% Fixed Income $100,000 $103,771 $107,573 $108,625 $108,563 N/A
MPT Portfolio $100,000 $98,316 $94,059 $83,340 $98,008 N/A
Warren Buffett Portfolio $100,000 $117,012 $120,465 $114,332 $124,083 N/A
Harry Dent Portfolio $100,000 $110,213 $96,567 $78,477 $97,076 N/A
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