Crackerjack Greenback Prudent Advice for a Prosperous Future

December 22, 2008

Comparison of the Diversified Portfolios

Filed under: Diversified Portfolios,Investing,Retirement Planning — Paul Williams @ Crackerjack Greenback @ 2:52 pm

       In the last post of my series on a closer look at a diversified portfolio, reader Nick asked if I could do a summary post comparing all the portfolios. I’m quite happy to oblige as it was something I was hoping to do anyway.

       First, let’s look at the historical performance and risk of all the portfolios. The chart below shows the average (arithmetic mean) return and standard deviation (a measure of risk) for each of the portfolios starting with the 100% Stock portfolio down to the 0% Stock (100% Bond) portfolio. The data used was from the time period of 1927 to 2007.

Historical Return and Volatility of Portfolios - Small

       We can clearly see that as you have a higher percentage in stocks your return goes up—but so does your risk. This is called the risk vs. return trade-off. A higher return generally means higher risk is involved, and lower risk generally means you’re going to get a lower return.

       The average return doesn’t really tell us much as we’ll probably never actually get the average return in any given year. Investment returns fluctuate, so it’s nice to see the range of returns we would have experienced in each portfolio. This next chart shows exactly that. For each portfolio, I’ve charted the highest, average, and lowest return over the 1927-2007 time period.

Portfolio Return Ranges (One Year) - Small

       Again, that’s all fine and dandy but it still doesn’t tell us much. When we invest, we generally don’t have a one year time frame so we shouldn’t be looking at single year returns. Most of the goals we invest for have time frames of 5, 15, or 30+ years. What we really want to know is how our returns will look over those time periods. How likely is our portfolio to lose money over 5, 15, or 30 years? What’s the lowest return the portfolio has experienced over a 30 year period? Those are the questions we should really be asking.

       To answer those types of questions, we have to look at things a little differently. For starters, we can’t use the average return over a 30 year period to figure out what the portfolio would have done. Because investment returns compound and vary each year, we have to use the geometric mean (click to learn more). This is also called an annualized return. It basically means that your return over a given time period would be like getting the annualized return every year—except that never actually happens in reality because investment returns vary from year to year.

       For example, an annualized return of 10% over a 5 year period means that $1,000 would have grown to $1,610.51. But your actual returns could have been very different. One 5 year period might have returns of 9%, -15%, 8%, 16%, and 39% while another 5 year period might have returns of 14%, 12%, -5%, 8%, and 23%. The average return for these periods was 11.4% and 10.4%, respectively, but you still would have ended up with about $1,610.51 in both of those 5 year periods.

       To really see the effect that time has on reducing our risk of losing money, we’ll have to keep the scale on the charts the same. So each chart has a highest return of 100% and a lowest return of -60%, even though none of the results actually go to those extremes. Let’s look again at the chart for the one year periods, then I’ll show you the 5 year, 15 year, and 30 year charts without interruption so you can really compare them all.

Portfolio Return Ranges (One Year) - Small

Portfolio Return Ranges (Five Year) - Small

Portfolio Return Ranges (Fifteen Year) - Small

Portfolio Return Ranges (Thirty Year) - Smalll

       Wow, that last chart is really bunched up isn’t it? What does that tell us? The longer we leave our money invested, the more likely it is we’ll get a result closer to the average. If you’re invested heavily in stocks, it also means that you’re more likely to get much higher than average returns as well. This is why you should be invested in a 100% Stock portfolio if you have more than 20-25 years until retirement, and it’s why you should probably have at least 70-80% in stocks until you actually do retire. By leaving most of your money in stocks for a long time, you increase your chances of getting the high returns you need while decreasing your chances of getting very low returns (for the entire time period your money is invested). Yes, you’ll have more volatility, but that won’t matter if your portfolio has grown large enough to exceed your needs.

       So do you want to see what those returns were like over the 30 year periods? The chart below is zoomed in with a better scale so you can really see the results.

Portfolio Return Ranges (Thirty Year) Zoomed In - Small

       Look closely at the data for that 100% Stock portfolio. The worst annualized return you would have had over a 30 year period was about 8.5%. Even if you invested just as the Great Depression was getting underway, you still would have made 8.5% a year over 30 years. That’s pretty amazing, and it’s exactly why we need to block out the noise from the financial media. Ignore the short term, invest in index funds, and go about living your life and enjoying your family and friends instead of watching the stock market all the time!

December 19, 2008

A Closer Look at a Diversified 100% Bond (0% Stock) Portfolio

Filed under: Diversified Portfolios,Investing,Retirement Planning — Paul Williams @ Crackerjack Greenback @ 3:30 am

       In my example of what a diversified portfolio looks like, I used a 70% Stock portfolio as an illustration. To save you the time and math, I’ve started a series of posts that look at a range of diversified portfolios from 100% Stock to 0% Stock. I’ll break these portfolios down in 10% increments. Today we’ll take a closer look at a 100% Bond (0% Stock) portfolio.

       Here’s a pie chart depicting the asset allocation for a diversified 100% Bond portfolio:

Allocation for 100% Bond Portfolio - Small

       Click here to learn how to invest in a diversified 100% Bond portfolio. Keep in mind that you’ll need $6,000 to meet the fund minimums for this particular portfolio. If you invest at Vanguard, the total expense ratio for this portfolio would be 0.18%.

       Here’s a chart showing the historical returns for this portfolio from 1927-2007:

Historical Returns for 100% Bond Portfolio - Small

Now for some quick facts about this 100% Bond portfolio:

  • The highest calendar year return for this portfolio was 19.5% in 1982.
  • The lowest calendar year return for this portfolio was -2.3% in 1956.
  • From 1927 to 2007, the average annual return for a diversified 100% Bond portfolio was 4.9%.
  • This 100% Bond portfolio never lost money during any consecutive 3 year period from 1927 to 2007.

       I would never recommend that anyone with a long-term time horizon invest in a 100% Bond portfolio. You get a much better return for very little additional risk by using a 20% Stock portfolio instead. That extra 20% of stock really does help to increase your return and long-term results significantly.

       If you have a short-term (< 5 years away) goal that you'd like to save for, I recommend using a high-yield savings account or U.S. Treasury Inflation-Protected Securities (TIPS). These will enable you to save for your goal while earning a reasonable interest rate with little to no risk.

December 18, 2008

A Closer Look at a Diversified 10% Stock Portfolio

Filed under: Diversified Portfolios,Investing,Retirement Planning — Paul Williams @ Crackerjack Greenback @ 3:30 am

       In my example of what a diversified portfolio looks like, I used a 70% Stock portfolio as an illustration. To save you the time and math, I’ve started a series of posts that look at a range of diversified portfolios from 100% Stock to 0% Stock. I’ll break these portfolios down in 10% increments. Today we’ll take a closer look at a 10% Stock portfolio.

       Here’s a pie chart depicting the asset allocation for a diversified 10% Stock portfolio:

Allocation for 10% Stock Portfolio - Small

       Click here to learn how to invest in a diversified 10% Stock portfolio. Keep in mind that you’ll need $375,000 to meet the fund minimums for this particular portfolio. If you invest at Vanguard, the total expense ratio for this portfolio would be 0.19%.

       Here’s a chart showing the historical returns for this portfolio from 1927-2007:

Historical Returns for 10% Stock Portfolio - Small

Now for some quick facts about this 10% Stock portfolio:

  • The highest calendar year return for this portfolio was 18.6% in 1982.
  • The lowest calendar year return for this portfolio was -5.5% in 1931.
  • From 1927 to 2007, the average annual return for a diversified 10% Stock portfolio was 5.8%.
  • During any consecutive 3 years from 1927 to 2007, this portfolio lost money 2 times out of a possible 79 periods. The two worst 3 year periods were 1929-1931 and 1930-1932 (Great Depression), when the portfolio lost about 2.7% and 0.3% of its original value, respectively.
  • This 10% Stock portfolio never lost money during any consecutive 5 year period from 1927 to 2007.

       I would never recommend that anyone with a long-term time horizon invest in a 10% Stock portfolio. You get a much better return for very little additional risk by using a 20% Stock portfolio instead. That extra 10% of stock really does help to increase your return and long-term results significantly.

       If you have a short-term (< 5 years away) goal that you'd like to save for, I recommend using a high-yield savings account or U.S. Treasury Inflation-Protected Securities (TIPS). These will enable you to save for your goal while earning a reasonable interest rate with little to no risk.

December 17, 2008

A Closer Look at a Diversified 20% Stock Portfolio

Filed under: Diversified Portfolios,Investing,Retirement Planning — Paul Williams @ Crackerjack Greenback @ 3:30 am

       In my example of what a diversified portfolio looks like, I used a 70% Stock portfolio as an illustration. To save you the time and math, I’ve started a series of posts that look at a range of diversified portfolios from 100% Stock to 0% Stock. I’ll break these portfolios down in 10% increments. Today we’ll take a closer look at a 20% Stock portfolio.

       Here’s a pie chart depicting the asset allocation for a diversified 20% Stock portfolio:

Allocation for 20% Stock Portfolio - Small

       Click here to learn how to invest in a diversified 20% Stock portfolio. Keep in mind that you’ll need $188,000 to meet the fund minimums for this particular portfolio. If you invest at Vanguard, the total expense ratio for this portfolio would be 0.20%.

       Here’s a chart showing the historical returns for this portfolio from 1927-2007:

Historical Returns for 20% Stock Portfolio - Small

Now for some quick facts about this 20% Stock portfolio:

  • The highest calendar year return for this portfolio was 20.8% in 1933.
  • The lowest calendar year return for this portfolio was -10.5% in 1931.
  • From 1927 to 2007, the average annual return for a diversified 20% Stock portfolio was 6.7%.
  • During any consecutive 3 years from 1927 to 2007, this portfolio lost money 3 times out of a possible 79 periods. In 1 of those 3 times, it lost less than 0.6% of its original value.
  • The two worst 3 year periods were 1929-1931 and 1930-1932 (Great Depression), when the portfolio lost about 12% of its original value.
  • During any consecutive 5 years from 1927 to 2007, this portfolio lost money only once out of a possible 77 periods. Even then, it lost less than 1.8% of its original value.
  • This 20% Stock portfolio never lost money during any consecutive 7 year period from 1927 to 2007.
  • This portfolio never averaged less than a 4.2% annual return during any consecutive 30 year period from 1927 to 2007.

       My hope is that this information will prepare you for the possible risk of investing in a 20% Stock portfolio while giving you some perspective during tough times. I think it’s really important to emphasize that last quick fact. If you have a time horizon of 30+ years, there is no historical period where you would have averaged less than a 4.2% annual return. (Even if you started just before the Great Depression!!!) Take comfort in that fact when the media barrages you with doom and gloom news every day.

December 16, 2008

A Closer Look at a Diversified 30% Stock Portfolio

Filed under: Diversified Portfolios,Investing,Retirement Planning — Paul Williams @ Crackerjack Greenback @ 3:30 am

       In my example of what a diversified portfolio looks like, I used a 70% Stock portfolio as an illustration. To save you the time and math, I’ve started a series of posts that look at a range of diversified portfolios from 100% Stock to 0% Stock. I’ll break these portfolios down in 10% increments. Today we’ll take a closer look at a 30% Stock portfolio.

       Here’s a pie chart depicting the asset allocation for a diversified 30% Stock portfolio:

Allocation for 30% Stock Portfolio - Small

       Click here to learn how to invest in a diversified 30% Stock portfolio. Keep in mind that you’ll need $125,000 to meet the fund minimums for this particular portfolio. If you invest at Vanguard, the total expense ratio for this portfolio would be 0.21%.

       Here’s a chart showing the historical returns for this portfolio from 1927-2007:

Historical Returns for 30% Stock Portfolio - Small

Now for some quick facts about this 30% Stock portfolio:

  • The highest calendar year return for this portfolio was 28.6% in 1933.
  • The lowest calendar year return for this portfolio was -15.5% in 1931.
  • From 1927 to 2007, the average annual return for a diversified 30% Stock portfolio was 7.4%.
  • During any consecutive 3 years from 1927 to 2007, this portfolio lost money 4 times out of a possible 79 periods. In 2 of those 4 times, it lost less than 3.3% of its original value.
  • The two worst 3 year periods were 1929-1931 and 1930-1932 (Great Depression), when the portfolio lost about 21% of its original value.
  • During any consecutive 5 years from 1927 to 2007, this portfolio lost money 3 times out of a possible 77 periods.
  • This 30% Stock portfolio never lost money during any consecutive 7 year period from 1927 to 2007.
  • This portfolio never averaged less than a 5.1% annual return during any consecutive 30 year period from 1927 to 2007.
  • In 27 of the 52 possible consecutive 30 year periods from 1927 to 2007, this portfolio had a return higher than its historical average of 7.4%. Nearly 52% of the time, you would have had a higher than average return for a 30 year time period.

       My hope is that this information will prepare you for the possible risk of investing in a 30% Stock portfolio while giving you some perspective during tough times. I think it’s really important to emphasize those last two quick facts. If you have a time horizon of 30+ years, there is no historical period where you would have averaged less than a 5.1% annual return. (Even if you started just before the Great Depression!!!) And 52% of the time, you would have had a higher than average return over a 30 year time period. Take comfort in those facts when the media barrages you with doom and gloom news every day.

December 15, 2008

A Closer Look at a Diversified 40% Stock Portfolio

Filed under: Diversified Portfolios,Investing,Retirement Planning — Paul Williams @ Crackerjack Greenback @ 3:30 am

       In my example of what a diversified portfolio looks like, I used a 70% Stock portfolio as an illustration. To save you the time and math, I’ve started a series of posts that look at a range of diversified portfolios from 100% Stock to 0% Stock. I’ll break these portfolios down in 10% increments. Today we’ll take a closer look at a 40% Stock portfolio.

       Here’s a pie chart depicting the asset allocation for a diversified 40% Stock portfolio:

Allocation for 40% Stock Portfolio - Small

       Click here to learn how to invest in a diversified 40% Stock portfolio. Keep in mind that you’ll need $94,000 to meet the fund minimums for this particular portfolio. If you invest at Vanguard, the total expense ratio for this portfolio would be 0.22%.

       Here’s a chart showing the historical returns for this portfolio from 1927-2007:

Historical Returns for 40% Stock Portfolio - Small

Now for some quick facts about this 40% Stock portfolio:

  • The highest calendar year return for this portfolio was 36.4% in 1933.
  • The lowest calendar year return for this portfolio was -20.5% in 1931.
  • From 1927 to 2007, the average annual return for a diversified 40% Stock portfolio was 8.2%.
  • During any consecutive 3 years from 1927 to 2007, this portfolio lost money 5 times out of a possible 79 periods. In 2 of those 5 times, it lost less than 4.2% of its original value.
  • The two worst 3 year periods were 1929-1931 and 1930-1932 (Great Depression), when the portfolio lost about 30% of its original value.
  • During any consecutive 5 years from 1927 to 2007, this portfolio lost money 4 times out of a possible 77 periods.
  • This 40% Stock portfolio never lost money during any consecutive 7 year period from 1927 to 2007.
  • This portfolio never averaged less than a 5.9% annual return during any consecutive 30 year period from 1927 to 2007.
  • In 29 of the 52 possible consecutive 30 year periods from 1927 to 2007, this portfolio had a return higher than its historical average of 8.2%. Over 55% of the time, you would have had a higher than average return for a 30 year time period.

       My hope is that this information will prepare you for the possible risk of investing in a 40% Stock portfolio while giving you some perspective during tough times. I think it’s really important to emphasize those last two quick facts. If you have a time horizon of 30+ years, there is no historical period where you would have averaged less than a 5.9% annual return. (Even if you started just before the Great Depression!!!) And 55% of the time, you would have had a higher than average return over a 30 year time period. Take comfort in those facts when the media barrages you with doom and gloom news every day.

December 14, 2008

A Closer Look at a Diversified 50% Stock Portfolio

Filed under: Diversified Portfolios,Investing,Retirement Planning — Paul Williams @ Crackerjack Greenback @ 3:30 am

       In my example of what a diversified portfolio looks like, I used a 70% Stock portfolio as an illustration. To save you the time and math, I’ve started a series of posts that look at a range of diversified portfolios from 100% Stock to 0% Stock. I’ll break these portfolios down in 10% increments. Today we’ll take a closer look at a 50% Stock portfolio.

       Here’s a pie chart depicting the asset allocation for a diversified 50% Stock portfolio:

Allocation for 50% Stock Portfolio - Small

       Click here to learn how to invest in a diversified 50% Stock portfolio. Keep in mind that you’ll need $75,000 to meet the fund minimums for this particular portfolio. If you invest at Vanguard, the total expense ratio for this portfolio would be 0.23%.

       Here’s a chart showing the historical returns for this portfolio from 1927-2007:

Historical Returns for 50% Stock Portfolio - Small

Now for some quick facts about this 50% Stock portfolio:

  • The highest calendar year return for this portfolio was 44.3% in 1933.
  • The lowest calendar year return for this portfolio was -25.4% in 1931.
  • From 1927 to 2007, the average annual return for a diversified 50% Stock portfolio was 8.8%.
  • During any consecutive 3 years from 1927 to 2007, this portfolio lost money 6 times out of a possible 79 periods. In 2 of those 6 times, it lost less than 4.2% of its original value.
  • The two worst 3 year periods were 1929-1931 and 1930-1932 (Great Depression), when the portfolio lost about 39% of its original value.
  • During any consecutive 5 years from 1927 to 2007, this portfolio lost money 5 times out of a possible 77 periods.
  • This 50% Stock portfolio never lost money during any consecutive 7 year period from 1927 to 2007.
  • This portfolio never averaged less than a 6.5% annual return during any consecutive 30 year period from 1927 to 2007.
  • In 37 of the 52 possible consecutive 30 year periods from 1927 to 2007, this portfolio had a return higher than its historical average of 8.8%. Over 70% of the time, you would have had a higher than average return for a 30 year time period.

       My hope is that this information will prepare you for the possible risk of investing in a 50% Stock portfolio while giving you some perspective during tough times. I think it’s really important to emphasize those last two quick facts. If you have a time horizon of 30+ years, there is no historical period where you would have averaged less than a 6.5% annual return. (Even if you started just before the Great Depression!!!) And 70% of the time, you would have had a higher than average return over a 30 year time period. Take comfort in those facts when the media barrages you with doom and gloom news every day.

December 13, 2008

A Closer Look at a Diversified 60% Stock Portfolio

Filed under: Diversified Portfolios,Investing,Retirement Planning — Paul Williams @ Crackerjack Greenback @ 3:30 am

       In my example of what a diversified portfolio looks like, I used a 70% Stock portfolio as an illustration. To save you the time and math, I’ve started a series of posts that look at a range of diversified portfolios from 100% Stock to 0% Stock. I’ll break these portfolios down in 10% increments. Today we’ll look at a 60% Stock portfolio.

       Here’s a pie chart depicting the asset allocation for a diversified 60% Stock portfolio:

Allocation for 60% Stock Portfolio - Small

       Click here to learn how to invest in a diversified 60% Stock portfolio. Keep in mind that you’ll need $63,000 to meet the fund minimums for this particular portfolio. If you invest at Vanguard, the total expense ratio for this portfolio would be 0.24%.

       Here’s a chart showing the historical returns for this portfolio from 1927-2007:

Historical Returns for 60% Stock Portfolio - Small

Now for some quick facts about this 60% Stock portfolio:

  • The highest calendar year return for this portfolio was 52.1% in 1933.
  • The lowest calendar year return for this portfolio was -30.4% in 1931.
  • From 1927 to 2007, the average annual return for a diversified 60% Stock portfolio was 9.5%.
  • During any consecutive 3 years from 1927 to 2007, this portfolio lost money 8 times out of a possible 79 periods. In 2 of those 8 times, it lost less than 1.2% of its original value.
  • The two worst 3 year periods were 1929-1931 and 1930-1932 (Great Depression), when the portfolio lost about 46% of its original value.
  • During any consecutive 5 years from 1927 to 2007, this portfolio lost money 5 times out of a possible 77 periods.
  • During any consecutive 7 years from 1927 to 2007, this portfolio lost money only once out of a possible 77 periods. Even then, the portfolio only dropped about 3.45% from it original value.
  • This 60% Stock portfolio never lost money during any consecutive 10 year period from 1927 to 2007.
  • This portfolio never averaged less than a 7.1% annual return during any consecutive 30 year period from 1927 to 2007.
  • In 43 of the 52 possible consecutive 30 year periods from 1927 to 2007, this portfolio had a return higher than its historical average of 9.5%. For nearly 83% of the time, you would have had a higher than average return over a 30 year time period.

       My hope is that this information will prepare you for the possible risk of investing in a 60% Stock portfolio while giving you some perspective during tough times. I think it’s really important to emphasize those last two quick facts. If you have a time horizon of 30+ years, there is no historical period where you would have averaged less than a 7.1% annual return. (Even if you started just before the Great Depression!!!) And 83% of the time, you would have had a higher than average return over a 30 year time period. Take comfort in those facts when the media barrages you with doom and gloom news every day.

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