When investing for the long-term. It's important to include investment assets that allow your portfolio to not only survive market fluctuations but also survive the constant erosion of buying power by inflation. This post provides a sample portfolio. Since I tend to invest directly in the underlying assets (stocks and bonds), I do not use this portfolio. However, my broad asset classes do match the percentages presented in this portfolio and this is the portfolio I recommended to my spouse in case I die or am incapacitated.
I think I've covered most of this in prior posts but I wanted to ensure all required information was contained in this post.
Defining Risk
When managing a portfolio the manager must balance risk from two separate categories of risk. The problem is, compensating for one risk (say capital risk) causes the manager to use assets that increase the portfolio to higher levels of the other type of risk (cash has almost no capital risk but it increases exposure to inflation risk).
Capital Risk - The risk of an asset losing value due to market fluctuations
Inflation Risk - The risk of an asset losing value due to inflation
The trick with Capital Risk is that over long periods of time (> 15 years), capital risks even out and it (arguably) is not essential to include multiple asset classes. As your investment horizon drops below 15 years, then the including mix of multiple asset classes becomes more important. When it drops below 10 year, including a mix of multiple asset classes becomes essential.
Portfolio Rebalance
Different types of assets (e.g. cash, bonds, stocks) tend to not increase and decrease value at the same time. For example, when there's a stock market crash, cash assets retain their value and sometimes bonds will increase in value. So a method of decreasing capital risk (which permits the manager to reduce inflation risk) is to invest in multiple asset types.
When one asset type (like stocks) increase in value, you sell enough assets to bring that asset type back into the desired percentage. This process is called rebalancing.
Mutual Fund
Mutual funds provide a means of buying a wide variety of assets of the same type with not much money. Mutual funds also provide a means of investing in stocks without having to perform a lot of research on individual stocks.
Sample Portfolio
This is the portfolio that I recommended that my wife use in the event of my death or incapacitation.
If the portfolio must last longer than the indicated duration (e.g. 40 years instead of 30), then I recommend not using greater than a 3% SWR. If you only require the portfolio to survive 30 years (e.g. from age 65 to age 95), then you may use up to a 4% SWR.
I think I've covered most of this in prior posts but I wanted to ensure all required information was contained in this post.
Defining Risk
When managing a portfolio the manager must balance risk from two separate categories of risk. The problem is, compensating for one risk (say capital risk) causes the manager to use assets that increase the portfolio to higher levels of the other type of risk (cash has almost no capital risk but it increases exposure to inflation risk).
Capital Risk - The risk of an asset losing value due to market fluctuations
Inflation Risk - The risk of an asset losing value due to inflation
The trick with Capital Risk is that over long periods of time (> 15 years), capital risks even out and it (arguably) is not essential to include multiple asset classes. As your investment horizon drops below 15 years, then the including mix of multiple asset classes becomes more important. When it drops below 10 year, including a mix of multiple asset classes becomes essential.
Portfolio Rebalance
Different types of assets (e.g. cash, bonds, stocks) tend to not increase and decrease value at the same time. For example, when there's a stock market crash, cash assets retain their value and sometimes bonds will increase in value. So a method of decreasing capital risk (which permits the manager to reduce inflation risk) is to invest in multiple asset types.
When one asset type (like stocks) increase in value, you sell enough assets to bring that asset type back into the desired percentage. This process is called rebalancing.
Mutual Fund
Mutual funds provide a means of buying a wide variety of assets of the same type with not much money. Mutual funds also provide a means of investing in stocks without having to perform a lot of research on individual stocks.
Sample Portfolio
This is the portfolio that I recommended that my wife use in the event of my death or incapacitation.
|
Type and Percent
|
Fund and Percent
|
|||
|
60%
|
Stock Mutual Funds
|
15%
|
Small Cap Value Index
|
VSIAX
|
|
15%
|
Large Cap Value Index
|
VVIAX
|
||
|
15%
|
International Value Index
|
VTRIX
|
||
|
15%
|
REIT Index
|
VGSLX
|
||
|
20%
|
Bond Mutual Funds
|
7%
|
Long-Term Gvmnt Index
|
VLGSX
|
|
7%
|
Intermediate-Term Corp Index
|
VBILX
|
||
|
6%
|
International Bond Index
|
VTABX
|
||
|
20%
|
Cash / Money Market
|
20%
|
Vanguard Prime Money Market
|
VMMXX
|
|
|
Total
|
100%
|
Total
|
|
Safe Withdrawal Rates (SWR)
A safe withdrawal rate is the rate you may withdrawal your money so that you do run out of money before the designated period ends.
The table below shows the likelihood your portfolio will survive given different safe withdrawal rates.
If you withdraw 4% of your portfolio for living every year, then the
portfolio is 85% likely to last 30 years or more. If you withdraw 3% of
your portfolio for living every year, then your portfolio is 95+%
likely to last 30 years or more.
|
SWR
|
Duration (yrs.)
|
Probability
|
|
2%
|
30
|
99.8%
|
|
3%
|
30
|
95%
|
|
4%
|
30
|
85%
|
Adjusting SWR
On
years in which your portfolio balance increases, you get to reset your withdrawal amount. If you originally got to withdraw 3% of a $1,000,000 ($30,000), then if your portfolio increased to $1,200,000 you would now get to withdraw $36,000.
On years in which your portfolio balance decreased, you keep your withdraw amount equal to the amount of the previous year. So if your portfolio decreased in value from $1,200,000 ($36,000 SWR) to $1,000,000; you would get to continue withdrawing $36,000 in year anyway.
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