Retired Ralph's Portfolio Theory
by MF DowMan
Recently in the Portfolio Management folder, a terrific discussion has been taking place regarding strategies for retirement. A reader wanted to know how to approach a retirement portfolio of $500,000 when he had a dual need: a requirement of $25,000 a year to live on and a desire to preserve capital. Our newest Motley Fool staffer, MF Pixy (aka Brazen1), did an incredible analysis of several options. I'd like to modify one option and summarize it here.
Peter Lynch argues strongly for the merits of staying fully invested in stocks, even when one's goal is current income. Using Lynch's premise and the Beating the Dow returns listed in Michael O'Higgins's book (updated since its release by various Fools here in the forum), what would happen if we pushed our reader's example back to 1973---when O'Higgins began his numbers?
Assume Retired Ralph has a $500,000 portfolio in 1973 and needs $50,000 a year to live comfortably. (I doubled our reader's original requirement so skeptics can't say, "Yeah, yeah, but what about *taxes* and *inflation*?") One of the big objections to using equities for a retirement portfolio is that people shudder at the thought of having to sell stocks to generate their annual "income" requirements. As we'll see, it's not such a bad idea, after all.
The following table condenses the results of Retired Ralph's portfolio. At the end of each year, $50,000 is deducted (through a combination of dividends and sold shares) to meet the next year's living expenses.
Year Beginning % Return Ending Expenses Portfolio
Balance Balance Total
1973 $500,000 19.64% $598,200 $50,000 $548,200 1974 $548,200 -3.75% $527,643 $50,000 $477,643 1975 $477,643 70.07% $812,327 $50,000 $762,327 ............................................................................................................................................. 1980 $1,033,530 40.53% $1,452,420 $50,000 $1,402,420 ............................................................................................................................................. 1985 $2,665,414 37.83% $3,673,740 $50,000 $3,623,740 ............................................................................................................................................. 1990 $6,659,288 -15.22% $5,645,745 $50,000 $5,595,745 ............................................................................................................................................. 1994 $14,772,760 8.08% $15,966,399 $50,000 $15,916,399
Obviously, those numbers can be staggering, but with that kind of growth, one could easily increase the annual spending requirement and not hurt the portfolio's long-term performance significantly. (Incidently, the two negative years in this truncated chart were the *only* two negative years since 1973, so you can see here the effect of the worst decline in the 22-year period.)
In the face of these kinds of numbers, I'm hard-pressed to buy the argument presented by "modern portfolio management" that adversity to risk is more important than portfolio growth. It seems to me the major risk such an approach overlooks is the opportunity cost of missing out on the returns presented by equities. And keep in mind, the Beating the Dow approach doesn't select fly-by-night companies; these are the bluest of Blue Chips. It's hard to imagine a group of stocks with a better relative safety ranking. So, if you're looking at a retirement option that flies in the face of Conventional Wisdom, Beating the Dow seems the Foolish choice.