Searching for the Perfect Portfolio – Part 1

binoculars-1209011_640Ever since I have decided to retire early I was always wondering what should be the perfect allocation of my portfolio. I want to accumulate wealth as fast as possible, but at the same time I don’t want to take any reckless risk that would wipe off the work of the years. The fastest way to get one million euro is to save 500k and put it all on red at the roulette table. But in case I lose it all on black, I would be extremely…. sad. I need a better plan!

In a series of a couple of posts I’m trying to find the perfect portfolio allocation. I want to make it as bullet proof as possible, therefore I’m looking for market extremes and analyse the performance of different portfolios from various aspects. I will use real data that is available for everyone online. For my calculations I’m going to use the historical data of Yahoo Finance. By the end of this series, I’m hoping to find the portfolio that would match my needs on a long term.

Firstly let’s take 3 guys (Steve, Bob and Mike) who all wish to retire early. They are all coming from similar financial backgrounds and they all set their early retirement deadline as January 2008. By January 2003 they have all managed to accumulate a portfolio that values USD 600,000. They believe that by adding USD 2,000 per month to their savings, plus reinvesting all received dividends, the remaining five years would be sufficient to reach 1 million USD, which would allow them to live from the interests/dividends plus a yearly 3% withdrawal from their savings.

There is one big difference between the three guys though: the content of their portfolio.

Steve is a kind of YOLO person and goes all-in with stocks, as he knows that on a long term stocks have the highest returns. He also knows that diversification is important, therefore he chooses Vanguard Total Stock Market ETF for his portfolio which tracks the performance of over 3.6 thousand stocks.

Bob is more like a bond guy. He has a conservative investment strategy, relies on regular and more or less predictable income. He chooses the iShares iBoxx Investment Grade Corporate Bond ETF for both stability and a bit of higher return than US Treasury Bonds.

Mike has a mixed portfolio from the above two ETFs. He made some research and his financial adviser also suggested him a 60% stock, 40% bond portfolio allocation. At the beginning of each year he rebalances his portfolio to this ratio.

Let’s see what happened to our heroes until their retirement in January 2008.

2008

This period was extraordinarily good for stocks. We are over the burst of the dotcom bubble and stock prices have quickly recovered. Of course this environment was perfect for Steve, who has retired with a 1.3 million portfolio and this time his only struggle is whether he should go to the Maldives or somewhere to the Caribbean for a well deserved holiday. Mike can’t complain either. He has also achieved his goal and has retired with a portfolio worth 1.13 million. Bob hasn’t reached his target though; his investment is amounting to USD 912k. Nevertheless since he is receiving nice enough distribution from his ETF each month, furthermore he has said FU to his boss at the Xmas party after drinking a bit too much, he still chooses early retirement instead of keep on collecting for a bit longer.

Now it’s 2016 and you are surely interested what has happened to the 3 guys. Remember that each of them has withdrawn 3% of their portfolio value each year, furthermore they also used the dividends to cover their expenses. The red line on the chart represents the date of retirement.

2016

Steve has chosen the Caribbean at the end of the day, but when checking his portfolio after returning home, he had some hard time during his first year of early retirement. The financial crisis hit him hard; in March 2009 his investment worth… 603k. Only 3 thousand more than he had in 2003 when we met him! 6 years have gone. Now let’s take he hasn’t died in a heart attack or did some stupid things with his portfolio and he stick to his original plan. He had a slow recovery but finally he made it. He had to wait until the end of 2013, but his portfolio worth the same as when he has retired. At the time I’m writing this post in September 2016, he has over 1.5 million. He has survived the financial crisis (even though he probably got 20 years older in one year) and even made some profit, all this without any extra investment! Well done Steve!

Mike also had some hard times. His portfolio has bottomed at 678k in 2009 but he has also recovered. He had a bit smoother ride than Steve, but the price of that is that now his investment worth almost 300k less than his friend’s. Still managed to keep his portfolio value after the retirement; even made some profit.

Bob, well he’s just Bob. His portfolio has also suffered some losses during the crisis, but has moved in a relatively narrow range. And it’s going like that ever since. He has never reached 1 million, in fact his investment value is slowly decreasing since 2013. The low, flat interest rate environment is not good for him, especially that he is withdrawing 3% of his investment each year.

Finally let’s have a look how their average monthly income (dividend plus withdrawal) looked like over these years:

monthly-income

Even though Bob’s portfolio only worth more than the other two guys in the beginning of 2009, the first 4 years he had the highest monthly passive income. This is due to the higher dividends his bond portfolio has generated at the beginning. Nevertheless the amount he can use on a monthly basis is continuously declining from the beginning, now he is doing the worst of them.

The financial crisis was hard not only on Steve’s portfolio, but also on his monthly pocket money. In 2009 he could use 1.5k less per month than in 2008. Nevertheless this amount is continuously rising since then. In 2015 he could spend (before taxes) over 6k per month. Not too bad…

Mike’s income is relatively stable over these years. He can better count on his future income, calculate his expenses years ahead and knows that even if there will be a stock market crash tomorrow (he has no illusions that he will see some of them during the rest of his life), his income will not be significantly impacted.

Who would you rather be? Steve, Bob or Mike? Don’t answer right away! In the next couple of posts of this series I will check how these guys would perform under difference situations. Like what if we met them only in 2004 under the same circumstances…? This will be the topic of the next post.

You can find the other parts of the Searching for the Perfect Portfolio series under the below links:

 

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