How to Make the 6-Step Investment Model Work Better

Two weeks ago we wrote about a 6-step investment model for retirees, and two days ago we saw that the model worked. Now we can show how to make it work better. The key is to further diversify the stock investments. Originally we used a mutual fund that reflects returns to 500 leading U.S. companies, and today we use one that reflects returns to the entire U.S. stock market.

In today’s example, stock investments are represented by the Vanguard Total Stock Market Index Fund Investor Shares, a mutual fund designed to mimic the entire U.S. stock market. It contains over 3,300 stocks, almost half of the 7000+ stocks traded on U.S. stock exchanges. The stocks in the fund are selected by a sampling procedure designed to reflect the behavior of all 7000+ stocks.

Bond investments are represented by the same fund used earlier: Vanguard Total Bond Market Index Fund Investor Shares.

During the 11-year period used here, the Total Stock Market fund shows superior performance and leaves a retiree in better shape. An investment of $100 in the Total Stock Market Fund ended the period at $106, while supporting an annual withdrawal of $4. That is $7 better than the result we reported using the Vanguard 500 fund. (See Table below)

A retiree starting the period with $400,000 would end with $424,000, a full $28,000 more than the Vanguard 500 fund gave, which was $396,000.

Investment literature seems to be clear that over long periods of time, smaller companies have grown faster than large companies. That would give a total stock market fund an advantage over the Vanguard 500 fund, which contains only large companies. Of course there is no guarantee that trend will hold in the future, but in the last 11 years, it did.

The table below shows that all of the investments containing stocks performed better with the Total Stock Market fund (in bold type) than with the Vanguard 500 fund (in brackets and regular type). The key features are still diversification, rebalancing, and low costs, and the Total Stock Market fund incorporates more diversification.