Should I Have Followed My Advisor's Advice?

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 |  Includes: DIA, IVV, SPY
by: Bob Wells

Summary

Retirement often calls for a new income investing strategy.

A number of strategies were recommended at the time of our retirement.

Three years later let's look at how each strategy performed.

I was a government employee for more than 20 years and a participant in our 401K program. I knew nothing about investing back then and simply decided to put 100% of my holdings in an S&P 500 Index Fund. It wasn't until 19 years later when I was about a year away from retirement that I started to really pay attention to my account. Prior to that time the idea of Bear Markets seemed meaningless. A year away from retirement, things started to look quite a bit different.

We had planned a retirement at age 62 in August of 2008. In the later part of 2007 I had made the decision to move all of all funds from the S&P 500 Index to a cash fund paying what was then a solid 3.5%. Clearly this proved to be a great decision.

During early retirement I worked regularly as a contract trainer. We made the decision at first to simply withdraw 3.5% to supplement our income, the amount paid at the time by the cash fund. By 2010, we saw a dramatic decrease in the rate being paid by that fund and realized we needed advice.

My advisor suggested a number of options: A move to an income fund designed for retirees, a more "aggressive option" and finally there was the option of an annuity.

My wife's advisor started with an interesting exercise and determined that we could withdraw 4% a year from our account plus inflation with a 70% chance of not running out of money. This was with a recommended mix of around 60% bonds and 40% stocks. When we showed concern, he mentioned 50% bonds and 50% stocks and again spoke at great length about the option of an annuity.

None of these approaches struck a chord with either of us. With the assistance of our best friends we ventured into the uncharted territory of self directed investing. My buddy was a believer in Dividend Investing so that was the path we took starting in February 2011. I started with a focus on high yield and began to panic a bit as summer approached. I began to reduce the number of high yield stocks and purchased more familiar Dividend Growth names.

I decided to look for those dividend stocks yielding 3% or more that had done better than the market during the 2002 and 2008 Bear markets. By the end of the year I had discovered that most of the stocks I was now invested in were Dividend Growth stocks. As you'll see in a moment we are more than happy with the results of that focus.

I thought it would be interesting to take a look at what might have been by seeing where we might be today if we had followed the advice that at the time "just didn't seem right." Each directly driven by the traditional concept of capital gain and 4% annual withdraw plus 3% inflation.

Let's assume for a moment we started on January 1st of 2011 with a portfolio of $250,000. We withdrew 4% each year, adjusted for inflation by 3% in 2012 and 2013. In year one we withdrew $10,000 at the start of the year. In year two, $10,300 and in year three, $10,609.

In the 1st scenario, we were presented with the most conservative of two target dated funds - the first designed specifically for retirees. It is focused on capital preservation. It is currently invested - 74% Treasuries, 6% - aggregate bond fund, 12% - S&P 500 Index, 3% - Small Cap Index and 5% Internationals.

In scenario 2, we are presented with the second fund targeted for those a few years away from retirement. It was recommended for those retirees willing to assume just a little more risk. It is invested in 43% Treasuries, 5% Aggregate Bond Funds, 28% S&P 500 Index, 9% Small-Cap Index and 15% International. This model has the highest risk of the three but with greater risk comes greater reward right?

In scenario 3, we use the model recommended by my wife's advisor a simple mix of 50% bonds - the aggregate bond fund and 50% stocks - the S&P 500 Index.

Let's start with scenario 1, the most "conservative" of the options suggested. In year one the fund delivered a gain of 2.23%, clearly under the 4% ($10,000) provided for income. So at the start of 2012, we have $245,352 in capital. $10,300 is subtracted for income. leaving capital of $235,052. During 2012, the fund delivered a gain of 4.77%. We started 2013 with capital totaling $246,264. We subtract $10,600 for income, leaving a balance of $235,655. In 2013, the fund returned 6.97%, we end 2013 with a portfolio valued at $252,080.

In Scenario 1, we would have paid the bills and we do end up three years later with the portfolio a tad more than $2,000 larger.

CAPITAL PRESERVATION FUND

Year

Starting

Balance

Income

Remaining

Balance

Total

Return

Ending

Balance

2011

$250,000

$10,000

$240,000

2.23%

$245,352

2012

$245,352

$10,300

$235,052

4.77%

$246,264

2013

$246,264

$10,609

$235,655

6.97%

$252,080

2014

$252,080

Click to enlarge

TARGET FUND

Let's move next to Scenario 2 - Again we start with $250,000, deducting $10,000 for income at the start of 2011. leaving $240,000. The fund returned .41%, for the year, leaving a slightly reduced portfolio with which to begin 2012. Again income is deducted, leaving $230,684. The fund grew by 10.42% for the year. This time $10,300 is deducted for income to adjust for inflation. The portfolio ended the year at $254,721. We start 2013 by deducting $10,600 for income, leaving a balance of $244,121. 2013 saw the fund return 16.03%. We start 2014 with a portfolio valued at $282,253.

Year

Starting

Balance

Income

Remaining

Balance

Total

Return

Ending

Balance

2011

$250,000

$10,000

$240,000

.41%

$240,984

2012

$240,984

$10,300

$230,684

10.42%

$254,721

2013

$254,721

10,609

$244,112

16.03%

$282,253

2014

$282,253

Click to enlarge

50% STOCKS/50% BONDS

Scenario 3- 50%/50% - Again we start with $250,000, deducing $10,000 for income at the start of 2011. This again leaves $240,000. The 50/50 fund has a total return of 5%. We begin 2012 with a portfolio now totaling $252,000. We deduct 10,300 for yearly income leaving a balance of $241,700.

For 2012 50/50 has a total return of 10.18%. We start 2013 with a portfolio of $266,305. We deduct $10,609 for income leaving $255,696. 2013 produces a negative return in the bond fund equal to (1.68%). Total return for 50/50 is 15.38%. We begin 2014 with a portfolio valued at $295,022, 18% higher than when we started after withdraws for income.

Year

Starting

Balance

Income

Remaining

Balance

Total Return

Ending

Balance

2011

$250,000

$10,000

$240,000

5.0%

$252,000

2012

$252,000

$10,300

$241,700

10.18%

$266,305

2013

$266,305

$10,609

$255,696

15.38%

$295,022

2014

$295,022

Click to enlarge

50% STOCKS/50% TREASURIES

Scenario 4 - 50%/50% Treasuries were added because it was used as the basis for early research on the 4% Withdraw Rule. Implied in the research was the notion that investors following this mix would likely not run out of money in a 30-year retirement.

Year

Starting

Balance

Income

Remaining

Balance

Total Return

Ending

Balance

2011

$250,000

$10,000

$240,000

2.28%

$245,472

2012

$245,472

$10,300

$235,172

8.77%

$255,797

2013

$255,797

$10,609

$245,187

17.17%

$287,286

2014

$287,286

Click to enlarge

It would appear that a mix of 50% stocks and 50% bonds invested in the Aggregate Bond Fund would be the better choice for those favoring such a mix.

DIVIDEND GROWTH PORTFOLIO

In scenario 5, we look at an account that started one month later than our first four examples in February of 2011 with $249,000. It is a diversified dividend growth portfolio with an overall beta under .70 made up almost exclusively from Dividend Champions, Contenders and Challengers.

In the first 11 months this portfolio collected $12,624 in dividends. $11,000 was taken as income during the course of the year with $1,000 per month being deposited into the owner's bank account the first of each month. The portfolio finished its first year valued at $264,523.

During 2012, the portfolio collected $13,417 in dividends and $1,100 per month was deposited the first day of each month. For the year $13,200 in dividend income was withdrawn. The portfolio ended 2012 valued at $308,777.

During 2013, $1,100 was withdrawn during the first three months only. During the remaining 9 months, dividends received were re-invested back into the account. Dividends totaling $16,060 were received during the year. The account ended 2013 valued at $365,525.

To make this a fair comparison with the other examples I'm deducting the $3,400 in additional dividends paid out in income for the above examples which would have left an end of the year balance of $361,125.

Year

Starting

Balance

Income

Remaining

Balance

Total Return

Ending

Balance

2011

$249,000

$11,000

$248,000

6.25%

$264,523

2012

$264,523

$13,000

$251,523

16.52%

$308,777

2013

$308,777

$3,300

$305,477

18.49%

$365,777

2014

$365,777

Click to enlarge

As you may have guessed by now, the Dividend Growth portfolio just described is mine. Here's a link to my complete portfolio at the end of the quarter.

My portfolio is subject to a portfolio business plan that helps direct my buy and sell decisions. Here's a link to that plan.

Ultimately, investing is about the choices we make. Looking at those we were presented at retirement I feel we made the best choice. I'm moving forward with a Dividend Growth portfolio that I'm confident can meet our objectives for income no matter what lies ahead.

Now it's your turn. What did your advisor recommend for your distribution stage portfolio? How are you handling the matter of withdraws from principal during retirement?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.