I don’t blame you. I know that the explosion of investment options has left you with an “I give up” feeling about choosing your investments. According to Morningstar, there are 231 different choices just in the ETF category of Large Cap Blend alone. There are 1206 choices if you choose to invest via mutual funds. Then you have individual stocks as well. So why not just put it all in a fund that tracks the tried and true S&P 500?
What follows is a look at the results of investing in the S&P 500 versus a portfolio that is equally weighted in Large Cap Growth, Large Cap Value, and Small Cap Value. As usual, we will compare two different 20 year periods. In the first analysis, we will contribute $500 per month and look at the final accumulation value. In the second analysis, we will start with $100,000 and distribute $416 per month (about 5% per year) over 20 years and see how things compare. I have chosen the period of 1972-1991. This is a very rough period in our economic history characterized by high inflation and low earnings growth.
Accumulation: 1972-1991
Portfolio 1: S&P 500 The simple portfolio ends the 20 year portfolio with a balance of $1,024,773. Not bad at all!
Portfolio 2: Large Growth, Large Value, Small Value The equal-weighted, three asset portfolio ends slightly higher, with $1,296,514. So diversification gives you about $275,000 more with less risk. The worst year for this portfolio is -24.82% versus -26.93% for the S&P portfolio.
Distribution: 1972-1991
This high inflationary period was devastating to an S&P 500 only portfolio. Just to get a grasp of how dramatic inflation was in this period, your initial withdrawal of $416 per month had to grow to $1378 per month to preserve your buying power! That is more than triple your initial withdrawal.
Portfolio 1 Ending Balance: $18,157
Portfolio 1 arrives at zero in year 22. This is not a long enough payout period for today’s investor unless you start your retirement distributions at age 72.
Adding Large Cap Value and Small Cap Value to the second portfolio significantly improved results. Small Cap Value stocks had an incredible run in this period, including a 10 year stretch in which they averaged over 30% return per year!
Portfolio 2 Ending Balance: $319,167
The diversified portfolio ends the 20 year period in 1991 healthy and at a current withdrawal rate of 5.7%. This portfolio could continue to make distributions even up to today, ending with a balance in 2022 currently of $3,279,659 and a annual distribution amount of almost $33,000 due to inflation adjustments.
Diversification really matters in the retirement phase! Don’t let the plethora of investments overwhelm you. It is worth it to build a broadly diversified portfolio with more than just Large Cap Growth stocks.