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Simplicity vs. Flexibility In Your Portfolio

By Scott Roark, MBA, PhD | December 18, 2020

There is much to be said for the practice of simplifying and de-cluttering in life.  It seems like I keep seeing consultants and tools that will help you clean out and organize your garage, your food pantry, or your closet.  It seems that the hoarding gene (apparently it resides in a region on Chromosome 14) is relatively widespread among us.

It turns out that this tendency to accumulate clutter can be fairly common in the financial arena as well.  If you change jobs, move around or respond to financial services marketing, chances are that you have more accounts than are really necessary for a smoothly functioning life.  While there may be some arguments to having more than a couple of accounts for a particular category, it may sometimes be easier to keep track of financial matters when you are not dealing with endless statements at the end of each month. This logic also transfers to the actual investments that make up your multiple accounts. The financial services industry has attempted to provide simplicity with an investment vehicle called a Target Date Fund.

Target Date Funds have been marketed is as a simplifying tool for retirement savings.  They can be appealing because, in one fund, you can get a well-diversified holding that can achieve a targeted asset allocation (or at least get very close to one). The theory behind Target Date Funds is rather than having a portfolio with a dozen or more varying asset classes, one simple fund may do it all. As a quick overview of Target Date funds, they have dates contained in their name that roughly correspond to a “targeted retirement date”, often occurring in 5-year increments. Funds with a target date in their name closest to the current year will theoretically have less volatility and more fixed income and cash-like holdings in them while funds with a target date in their name furthest from the current year will be invested in a more growth-oriented manner. For example, a fund sponsor may have funds that range from a 2020 fund that might have 35% in stocks and 65% in fixed income and cash-like holdings while a 2065 fund could be allocated to 90% stocks and just 10% in fixed income and cash-like holdings.

Obviously, a full discussion of Target Date funds is beyond the scope of this simple article.  I will get into more depth on these complex funds in the future, perhaps on one of our EDU podcasts! But in terms of adding simplicity to your portfolio, they may be an attractive tool, especially in the accumulation phase of retirement planning – that period of time when you’re just adding to your portfolio every month and you are not taking any distributions.

However, in retirement when you begin sending your savings and living off them, I would argue the simplicity that Target Date funds offer starts to lose its appeal.  In the distribution phase of retirement planning investment flexibility become more valuable than account holding simplicity.  Unfortunately, that is where a Target Date fund can lose some appeal.  For instance, consider the situation of March 2020 when the Corona Virus scare had the equity markets down 30%+ in a short period of time. However, in the same period, some fixed income and cash-like holdings (not all, but some) held steady or even gained in value.  If you were taking a $20,000 quarterly distribution from your retirement funds in March, it would have been nice to pull from the fixed income or cash-like holdings that were more stable in value and had not dropped rather than selling your stock holdings which had likely dropped in value. This is where the simplicity of a Target Date fund loses out to its inflexibility.  If all your assets are in a Target Date fund, you can’t choose to sell the winners and leave the losers alone. If the Target Date fund’s “losers” dropped enough that they took the entire fund’s value down, even though the fund holds some “winners”, you must still sell the entire fund as one. There is no picking and choosing allowed!  It is the proverbial “Throwing the baby out with the bathwater” conundrum.

When you are close to, or in retirement and you are actively spending from your portfolio, I think it is better to have the flexibility that comes from breaking your actual retirement portfolio into its constituent parts.  At Jim Saulnier & Associates we call this “positioning” and it allows you the flexibility to pick and choose what holdings you sell under what market conditions.

Target Date funds and others in their ilk, do offer simplicity and can be a useful option to busy professionals lacking the time and inclination to monitor and manage an investment portfolio during their accumulation years. But in retirement, when assets must be sold to fund your spending needs, I would suggest you opt away from simplicity and begin “positioning” your portfolio for spending by utilizing separate low-cost passive asset classes in your portfolio for the spending flexibility they afford. After all, babies should not be thrown out with the bathwater!


Additional Disclosure:

Diversification and asset allocation strategies do not assure profit or protect against loss. Past performance is no guarantee of future results. Investing involves risk. Depending on the types of investments, there may be varying degrees of risk. Investors should be prepared to bear loss, including loss of principal.

Re-Balancing Your Portfolio: Part 2

By Scott Roark, MBA, PhD | December 20, 2019

Re-Balancing with Numbers

In a recent blog post, I discussed the importance of re-balancing and how it fits into the spending phase of retirement.  In this article, I want to look at some specific re-balancing with numbers and how it has worked out over the past 5-15 years.  The numbers I put together actually go back 17½ years, but that doesn’t sound quite as nice as 5, 10 and 15-year horizons.  Nevertheless, in the table showing the summary results, I will include the 17½ year results as well.

Key Assumptions

In any re-balancing evaluation, there are a few key assumptions needed.  One is how often a re-balance will occur.  In this case, I did it every six months – at the beginning of each year and mid-way through each year.  Another key assumption is what you are starting with and, when considering the spending phase of retirement, what your regular withdrawal is.  I assume a $1 million initial account balance, with a 4% annual drawdown, paid out twice a year.  I further assume annual inflation of 3% over the analysis.  Given that all of these are assumptions, that means all of these could be argued about and fussed over, but they provide a reasonable starting point for the discussion.


Next for the mechanics of re-balancing.  For a portfolio, you start with a target allocation (for instance 45% US stocks, 15% international stocks, 30% US bonds and 10% international bonds) and at re-balancing, you buy or sell enough of the holdings to return to the target allocation.  For instance, if we assume a starting point of January 1, 2002 and look at a re-balance six months later, one will see that the broad stock market in the US declined by about 14% and an index of international bonds increased in value by about 11.5%.  In terms of re-balancing, because the US stocks have declined and the International bonds have increased, this will mean that the allocation has moved away from the target.  In order to return to the target allocation, one would sell some International bonds and buy some US stock funds – in just the right proportions to get you back to your desired allocation.

Model Portfolios

Before I get to the numbers, one last piece of description is needed.  Over a 17½ year window, I considered five different portfolios which closely mirror five model portfolios from Morningstar.  The five portfolios are Conservative (20% equity/80% fixed income), Conservative Growth (40% equity/60% fixed income), Moderate (60% equity/40% fixed income), Moderately Aggressive (80% equity/20% fixed income) and Aggressive (95% equity/5% fixed income).  While the equity and fixed income are the two broad asset classes, we use 5-6 low cost index funds in each portfolio to get exposure to subsets of the two broad classes (e.g. international bonds and international stocks).  Based on the asset allocation, these model portfolios reflect increasing risk moving from Conservative to Aggressive and they would also reflect increased expected return.

Now to the Numbers

Over a 17 ½ year window starting in January 2002, the Conservative Portfolio held up well.  The ending value of the portfolio was about $1,040,000 and it paid out the twice-a-year drawdowns without any issues.  The lowest account balance was $962,000 and occurred in July 2002 (right after “retirement”).  With the financial crisis of 2008-2009, the portfolio held up well – going from a high point of $1,075,000 in January 2008 to a low point of $970,000 in January 2009[1].  During that short window, the portfolio paid out over $48,000 in drawdowns as well.  In all, the portfolio made payments of over $900,000 (the starting point was $40,000 per year, but that grows with inflation!) over the 17 ½ year horizon.  Finally, the standard deviation – a measure of how volatile the portfolio value was – was $46,889.  In all, it was a relatively smooth ride for the Conservative portfolio since January 2002.  In the table below, I show some key metrics for the 5, 10 and 15-year intervals as well.

Metric 5-Year Window 10-Year Window 15-Year Window
Ending Value[2] $984,000 $1,230,000 $1,097,000
Low Point $925,000 (Jan 2019) $1,064,000 (Jan 2010) $972,000 (Jan 2009)
High Point $991,000 (Jan 2015) $1,232,000 (Jul 2014) $1,160,000 (Jul 2014)
Amount Paid[3] $214,000 $462,000 $751,000
Standard Deviation $22,098 $60,531 $51,694


That is a lot of numbers to digest – and we’ve only considered the Conservative portfolio!  The big takeaways I see here are the fact that the Conservative portfolio acted like it should – it maintained a relatively stable value (relatively low standard deviation) and it largely kept up with inflation by maintaining most of the principal and paying out an inflation adjusted $40,000 per year.

In the interests of space, I am going to conclude this blog post with a look at the other extreme – the Aggressive portfolio.  It is made up of 95% equity with 5% in fixed income so we would expect it to be much more volatile over time.  With the 17 ½ year horizon, this portfolio is much more affected by the tail end of the market downturn from 2001-2002.  With a retirement modeled as happening on January 1, 2002, the Aggressive portfolio takes an immediate dive down to $800,000 by the start of the next year.  However, the market recovered and the portfolio value went inexorably up – moving to $1,550,000 by July 2007 – all the while providing money for drawdowns.  Of course, there was a rather large correction in 2008-2009 and the portfolio again took a dive – this time down to $880,000 (as measured in January 2009).  Over the last 10 years, however, this particular portfolio has enjoyed a very healthy, if bumpy, ride up and the highpoint of $1,941,000 is reached with the ending value  (as of July 2019).  Of course, with each new day it seems that there is a new record for the stock market, so this portfolio – currently – is sitting pretty.  But there was a price to be paid for all the growth – the volatility was breathtaking over the past 17 ½ years.  The standard deviation over that time in the portfolio value was $313,618.  Below is the table showing the other time horizons for the Aggressive portfolio.

Metric 5-Year Window 10-Year Window 15-Year Window
Ending Value[4] $1,155,000 $2,311,000 $1,739,000
Low Point $925,000 (Jan 2016) $1,109,000 (Jul 2010) $762,000 (Jan 2009)
High Point $1,155,000 (Jul 2019) $2,311,000 (Jul 2019) $1,739,000 (Jul 2019)
Amount Paid[5] $214,000 $462,000 $751,000
Standard Deviation $83,519 $379,450 $257,067


There are a couple of things to point out with these numbers as I conclude.  First, it is apparent that the 10-year window is the best for this portfolio – which makes a great deal of sense.  We’ve had a (largely) uninterrupted run up in equity values over the past 10 years – minor corrections notwithstanding (the standard deviation tells the tale of the bumpiness involved).  This portfolio was far more volatile than the Conservative one – as it should be.  But with that came a much higher ending value – especially when one considers longer horizons.

I’ll plan on one more blog post on this re-balancing topic and we’ll look at what happened with the Conservative Growth, Moderate and Moderately Aggressive portfolios there.

[1] The low point is as of re-balance dates – not the absolute lowest point over the life of the portfolio.
[2] The initial value is always assumed to be $1,000,000.
[3] The amount paid is based on an assumed 4% withdrawal rate (i.e. $40,000 per year) starting at the appropriate time.
[4] The initial value is always assumed to be $1,000,000.
[5] The amount paid is based on an assumed 4% withdrawal rate (i.e. $40,000 per year) starting at the appropriate time.

Re-Balancing Your Portfolio: Part 1

By Scott Roark, MBA, PhD | December 6, 2019

Good discipline in investing is important in the years leading up to retirement – the accumulation phase of retirement planning.  It is important not to get too carried away if the market is going well by thinking stocks will move inexorably up.  Since March 2009, it feels like that has been the case and there are a number of investors who have come of age in the current bull market and all they know is up, up, up (interrupted briefly by small dips on the way to the next high).  But at the same time, investors can’t get carried away if the market has a correction by thinking here comes a repeat of 2008.  Re-balancing your portfolio – and having a balance of perspective with that – is important.

That is no less true in the retirement years – the spending phase.  It is just as easy to get carried away in either direction – either euphoric expectations of permanently rising markets or a melancholic belief that the next recession is just around the corner.  Either perspective can be dangerous and lead to investing behaviors that don’t serve retirement well.  Being too aggressive in a portfolio allocation can cause mayhem – especially if a correction like the one in late 2018 washes away 19% of the market value of stocks.  But being too cautious can also limit retirement spending.  In many cases, retirement will last 20-30 years or more and the “go-go” phase of retirement can last from 8-20 years or more depending on when retirement happens.

A commonly used tool to help smooth the ride, both in the accumulation phase and the draw-down phase of retirement, is re-balancing your portfolio regularly.  This act of selling assets and asset classes that have increased in value and buying assets and asset classes that have lagged can help a portfolio over the long term meet the goals that an investor has.  A disciplined approach to re-balancing your portfolio is a nice counterbalance to the temptation to engage in market timing that hurts so many individual investors.  Study after study shows the futility of market timing – where investors jump in because they think things are about to take off or sit on the sideline waiting for the next big drop.

I recently came across a podcast (not the Retirement and IRA Show ®) from 2017 where investors were fretting about a market top and the high probability of a correction in the near future.  Going back and looking at what has happened since the March 2017 podcast reveals some big missed opportunities:  the S&P has gone from around 2,350 to around 2,950 as I write this.  That’s a 25%+ increase and doesn’t include an additional 5% or so in dividend yield.  Clearly, someone who thought the market was too high in March 2017 would be leery of buying today.

Now I should include a quick comment to assure any readers that I understand that the market did not move in a straight line up over the past 2 ½ years.  There were clearly bumps along the way, including a rather disconcerting plummet in the fall of 2018.  But an investor with a longer horizon (even someone in retirement) doesn’t have to sweat these changes too much if there are a few things that are true about their portfolio:

  1. They have an appropriate balance in their portfolio of fixed income investments, equity investments and principal protected assets. The worst thing for a retired investor to face is a big hit from sequence of return risk where they need to liquidate investments for current expenses and those investments have taken a large drop in value.  Having a diversified portfolio means that an investor can liquidate some holdings that haven’t experienced a drop to fund expenditures.
  2. They have re-balanced regularly – selling winners along the way and buying more of the laggard. In a roaring bull market, that means regularly paring back the exposure to the volatile stock market and picking up more fixed income securities.
  3. They have a buffer asset – perhaps equal to 1-2 years of expenses. The presence of an asset that is liquid and principal protected that can cover expenses over a 12-24 month horizon should give a lot of security to an investor and allow them to stay the course, stay invested and not try to time the market.  If they’ve gone a step further and bucketed for a longer period of time (6-10 years), there is no good reason to worry about a market drop and no real benefit to trying to time the market.  While the most recent drop in the market in the fall of 2018 just took a few months to turn around, even the gut-wrenching fall of the great recession was largely recovered in 3 ½ years (from a high Oct 2007, the S&P recovered to within 10% of its high by Feb 2011) and was fully recovered in 5 ½ years – by Feb 2013.

In a future article, I will look at each of our Convenience Portfolios and examine how they performed over various time frames for a retiree who stuck with the portfolio, re-balanced regularly (every six months) and drew down money.  The examples will show that sticking with a portfolio, staying invested and regularly re-balancing your portfolio goes a long way towards reaching goals in a portfolio.