How 100 Pct Equity Beats Diversified Retirement Portfolio

Fidelity Investments recently sent its clients a “Fidelity Viewpoint” entitled Five Ways To Protect Your Retirement Income.

The viewpoint presents the conventional wisdom: the more risk adverse you are, the more conservative your portfolio should be. That is if you are afraid of market variation, you should have a portfolio that is high in “safe” securities; bonds, short term investments, even cash.

I disagree.

I believe that every investor, regardless of his risk aversion quotient, will be best served with a portfolio consisting of only one equity security. That security is Vanguard’s VTI, an index fund that precisely tracks the 3500 USA publicly traded stocks. However, since there is more data for Vanguard’s VFINX, which tracks the S&P 500 index, I will use data for S&P 500. Bear in mind, VTI has outperformed VFINX,  so the results of this paper are understated vis-a-viz VTI.

Risk, Diversification and Return.

Granted,  a 100% equity portfolio will lose a larger percent of its value in a down market but,the fact is,

losing a big percentage of a BIG amount still leaves you with a lot more money than

losing a small percentage of a little amount.

Would you rather lose 40% of $100,000 or 12% of $50,000?

Using a 100% equity allocation will create a much larger portfolio value than any other allocation. The table below demonstrates that you will have much more money in your 100% equity account and therefore, you can tolerate a larger percentage loss.

Here is the table presented by Fidelity that shows market results of four portfolio allocations. I added a fifth column showing the 100% equity allocation to the S&P500.

Capture

Fidelity’s Risk Based Portfolios

S&P500 ONLY
Average:  11.35%
Best 12 Months: 61.0%
Worst 12 Months -43.4%
Best 5 Years: 30.00%
Worst 5 years: -43%

Portfolio Values At 5 Year Intervals

Capture

Source for 11.35% Average Annual Return*

S&P Annualized Returns over multiple periods

What Happens When The Market Declines?

Source For S&P Worst 5 Year Period

The chart below introduces the concept of Monthly Rolling Periods. The “Examples of 15-Year….” illustrates the concept better than words.

The table shows that the worst 5 year period for the S&P 500 was March 2004 to February, 2009.

S&P Rolling Periods 1-10 years

The annualized rate of return for that period was -6.63%. That is the value that was used in the S&P 500 calculations presented in the table below. The table shows the value of each of the Fidelity portfolios if the market declines by the percentages indicated in the Fidelity table and the value of the S&P portfolios. It uses -6.63 annual decline for each of 5 year periods for the S&P500 portfolio. The table shows the value of each of the portfolios if the market declined by the proscribed percent at the end of 5 years, or at the end of 10 years, or at the end of 15 years, etc.

100% Equity Leaves Investor With More Money Irrespective of Market Decline

The calculations decreased the value of

Capture

The Very Aggressive, 100% S&P portfolio is ALWAYS is worth more than any other portfolio even though it loses a larger percentage of its total value over any 5 year “worst” period. The risk of “running out of money” is greater with the more conservative portfolios because they are not growing as fast – EVEN THOUGH they lose a smaller percentage during downturns.

The Optimum Portfolio?

The optimum portfolio is the one that grows faster than any other, one that is less likely to run out of cash than the others, one that keeps up with inflation. The 100% equity portfolio achieves these objectives. Even though you may lose a larger percentage of the portfolio in a downturn, you will still have more money than if you had been more conservative.

Data Source for S&P 500 Values

Growth…

The table below was developed by Index Fund Advisors. It shows that for the 30 year period, 1985 – 2014,  the S&P 500 Index fund returned an average of 11.35% each year.

 

Worst 5 Year Period…