Checking Up on Alice—Portfolio Review

Four Investments, 1997-2012

Last weekend TV viewers watched the beginning of the third season of BBC’s Downton Abbey, a story about an aristocratic family in England in the 1920s. Sir Robert Crawley, Earl of Grantham, with his family and staff, live on investments in a splendid castle.

Last July readers of this blog met Alice, a model retiree, who also lives on investments and manages her portfolio of four different index mutual funds. Moreover, Alice has Social Security and a pension, both of which postdate Lord Grantham.

Another year ended a few days ago, and it is a good time to see how Alice is doing, especially in comparison with Sir Robert Crawley.

Alice is a passive investor. She aims for investment returns very close to the average in her chosen markets: United States (US) stocks, US bonds, US Real Estate Investment Trusts (REITs), and international stocks. Those four markets represent a broadly diversified collection of assets.

Here are Alice’s asset allocations, mutual funds, and her 2012 investment returns:

Alice’s weighted average return for her portfolio was 11.58%, which is much higher than her 1.59% return for 2011. As did many investors, she had a good year. She has no major expenditures planned for 2013, so she decides to continue her $12,000 withdrawal. That amount was 4% of her initial portfolio of $300,000. Instead of hoping to spend more on clothes, cars, restaurants, or similar items, Alice is thinking about long-term care and about having money for heirs. We might think that being 12 years into retirement, Alice has settled on a way of life and is happy with her standard of living. Friends, family and activities mean more to her now than spending money.

She selected Vanguard funds because they are low-cost, they track relevant indices, and they are sponsored by a reputable firm. She is not working regularly with a financial advisor, so her total investment costs are those incurred by the funds she owns.

There are other companies that offer low-cost index funds, and in time I’ll offer a small survey of some of the alternatives. Also, there are other reasonable investment strategies that investors may use, including different assets, different allocations, or perhaps a mix of some individual stocks or bonds added to a core portfolio of index funds. There are many approaches to successful investing, but for now, for people like Alice who are unschooled in investment theory and practice, the method developed here with four low-cost, well diversified mutual funds is a serviceable and reasonable way of achieving market returns year after year.

Alice ended 2012 with $443,380, which is 48% more than she had at the beginning of retirement. She just withdrew $12,000 for living expenses in 2013, which will supplement her pension and Social Security. That leaves her portfolio at $431,380. Assuming she was 65 years old at retirement, she is 77 now.

All four of her funds made money in 2012, with stocks and REITs performing especially well. It might be tempting to think Alice could have done so much better if she had dropped bonds and invested only in stocks and REITs. The same thought is tempting this year. With US Treasury bond yields near zero, bond prices are about as high as they can reasonably go. If inflation accelerates or if the demand for US Treasuries falls, bond performance could sink. Since bonds are 42% of the portfolio, it might be a good time to reduce that allocation. Should Alice do that?

Of course no one knows which markets will perform well this coming year. Stocks could decline from a global slowdown in growth, and inflation may not occur.

Alice knows that she isn’t a good prognosticator, and more to the point, she knows that very few investment forecasters are consistently right. Whom should she follow? Alice, like so many passive investors, prefers to spend her time on other activities. So she sticks to her discipline, confident she will succeed over the long haul. Twelve years into retirement, and having lived through a volatile period in which many investors lost huge sums, Alice succeeded. As the updated table shows, Alice ended 2012 with $143,380 more than when she retired (for readers who need help with the table, see How Boomers Can Get Along with Their Investments and Two Important Benefits to Rebalancing Risk in Retirement Investments for explanations).

I am thinking now of Downton Abbey and Sir Robert Crawley, who is an active investor. Last Sunday we saw Lord Grantham cry over losing his American wife’s fortune in a Canadian railroad investment. He paced around his adviser’s office exclaiming that everyone believed it to be a sure thing, promising huge returns. Instead, the railroad is bankrupt, and viewers are led to believe Lord Grantham’s stock value is zero. What will happen to the Crawley family as they search for alternative income? Will they lose their castle?

We might imagine that Alice watched the show with a wry smile.

Alice Numbers 130110