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Safe withdrawals for portfolios with 3 or more asset classes.

Safe withdrawals for portfolios with 3 or more asset classes.

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The article was first posted on January 1, 2001.

Most of the studies on retirement withdrawals such as the Trinity Study and the Retire Early Study on Safe Withdrawal Rates limit the investment mix to two asset classes (i.e., short-term fixed income securities and an S&P500 index fund). Several readers have asked, "Would adding more asset classes to my retirement portfolio increase the ďsafeĒ withdrawal rate?Ē Maybe it would. Unfortunately, there isnít much in the way of data going back to 1926 or so for many of the asset classes of interest, so itís difficult to know for sure.

One author who has done considerable work on asset allocation is William J. Bernstein, the creator of the Efficient Frontier web site. While not specifically addressing retirement withdrawals, the December issue of SmartMoney magazine had an article that detailed Bernsteinís ideas on a widely diversified 9 asset class portfolio. This model portfolio is reproduced in the table below.

WITH S&P 500*
Short-Term Corp. Bond
40 0.47 6.2 5.9 0.25 6944
Total Stock Market
15 0.93 20.5 22.3 0.20 19607
Small Cap Value
10 N/A 13.5 N/A 0.25 236
S&P Value
10 0.83 9.2 18.6 0.22 3372
Emerging Markets
5 0.50 11.7 2.2 0.58 1093
European Stock
5 0.51 10.4 17.9 0.29 5846
Pacific Stock
5 0.40 9.1 0.9 0.37 2144
5 0.11 12.6 N/A 0.33 1068
Small Cap
5 0.38 27.4 14.6 0.25 3990
Overall portfolio
( N/A)
N/A 0.60 11.9 11.0 0.27 N/A
S&P 500 index fund
N/A 1.00 16.5 24.0 0.18 89,400

Bernsteinís study is based on data from 1973 to 1992. Itís quite a leap to extrapolate these results back to 1929, the worst case period identified in more comprehensive studies using longer data series. Also, while itís true that holding several asset classes reduces the standard deviation of the portfolio, it may also reduce your returns. Bernsteinís model portfolio had a 5-year compounded return of 11% per annum. A retiree holding an S&P500 index fund over the same period would have enjoyed a 24% average annual return and ended that 5-year period some 70% richer. Of course, past results donít guarantee future returns.

Texas-based financial planner Jaye Jarrett did a retirement withdrawal study in 1999 that considered three asset classes using a data series from 1926 to 1998. He showed that a portfolio of 37.5% S&P500, 37.5% small cap, 25% 5-year Gov't bonds, beat a portfolio of 75% S&P500 and 25% bonds. He calculated an increase of 21 basis points (4.21% vs. 4.00%) in the "100% safe" inflation-adjusted withdrawal rate for a 30-year pay out period. Table 5 of Jarrettís report details the results for inflation-adjusted withdrawals using large and small cap stocks.

Thereís probably little risk in expanding the stock portion of your portfolio beyond the S&P500 as long as youíre careful to keep management fees low. For example substituting the Vanguard Total Stock Market Index (VTSMX) for the S&P500 index fund (VFINX) would give you exposure to mid and small cap stocks (the market cap weighting of the Vanguard Total Stock Market Index fund is 73% S&P500, 18% mid-cap and 8% small cap) while only increasing the expense ratio by 2 or 3 basis points. More complicated strategies with higher management fees should be approached with caution.

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Copyright © 2000 John P. Greaney, All rights reserved.

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