commodities and precious metals, have also gone


through prolonged slumps at times. The verdict: Partially true, but greatly


oversimplified. Diversification remains a sound strategy, but it is an insurance policy that has a cost and will not always pay off.


Use 4 Percent of Assets to Determine Portfolio Withdrawals in Retirement


Investors and financial advisors have long relied on Bill Bengen’s landmark research on sustain- able withdrawal rates, which found that for a portfolio combining 50 percent stocks and 50 percent bonds, setting an initial withdrawal equal to 4 percent of the portfolio’s starting value and then adjusting each year’s withdrawal amount for inflation has historically never fully depleted portfolio’s value, even during some of


The verdict: Age-based guide- lines are a reasonable starting point but might be on the conservative side overall.


Diversify Your Portfolio to Reduce Risk and Improve Returns


It is often said that diversification is the only free lunch in finance. This quote, usually attributed to Nobel Laureate Harry Markowitz, refers to the power of diversification to reduce risk without


necessarily hurting returns. Why it works: In many ways, diversification


does have incredible power. Within an asset class, adding up to about 20 additional securities can dramatically reduce a portfolio’s overall risk pro- file. And adding asset classes with lower correla- tions is where the magic really happens. The lower the correlation, the bigger the reduction in volatili- ty. It is one of the few cases where the whole can be more than the sum of the parts; a well-constructed portfolio can have better risk-adjusted returns


than its component parts alone. Limitations: The problem is that correlation


coefficients shift over time, so what worked in the past will not necessarily work in the future. In addition, adding asset classes to reduce volatil- ity can also drag down returns, sometimes over multiyear periods. International diversification, for example, might have seemed like a no-brain- er for investors about 30 years ago, given that international-stock indexes had handily outper- formed from 1982 through 1991 and also showed a low correlation with U.S. market benchmarks. But over the past 10 years, non-U.S. markets have generally underperformed, and international diversification has dragged down returns more often than not. Other popular diversifiers, such as


the worst market periods since 1926. Why it works: This is another rule of thumb


that has stood the test of time because of its ability to cut through complexity and provide reassurance about one of the biggest fears for retirees: running out of money. It is also useful because it can be easily reverse-engineered to determine a required savings amount for retire- ment. A 4 percent spending guideline would dic- tate a starting portfolio equal to 25 times annual spending. If you know that you want to spend $50,000 per year in retirement, for example, you can multiply that amount by 25 to figure out that


you will need a portfolio size of $1.25 million. Limitations: The 4 percent rule assumes that


inflation-adjusted withdrawals remain at the same level year in and year out during retirement, regardless of market performance or changes in spending needs. In practice, many retirees spend more in the early years of retirement on travel and other pursuits, then spend less as they age and more toward the end of life because of med- ical costs or long-term care. There has also been extensive research about more flexible approach- es to withdrawals, such as setting guardrails based on portfolio size or market performance. In addition, there is some question about whether 4 percent will still be sustainable in an era of lower bond yields, which will likely weigh down returns


for portfolios that include fixed income. The verdict: The 4 percent rule is still a rea-


sonable starting point, but investors may want to use a slightly lower number to account for poten- tially less robust long-term returns. Most of the rules of thumb discussed above


have stood the test of time. Understanding some of the nuances behind how they can—or can not—support a sound portfolio strategy can help investors apply them more effectively. •


Nina Azwoir, First Vice President of Investments, Wintrust Wealth Management. © Morningstar 2020. All Rights Reserved. Used with permission. Securities, insurance products, financial planning, and invest- ment management services offered through Wintrust Investments, LLC (Member FINRA/ SIPC), founded in 1931. Trust and asset management services offered by The Chicago Trust Company, N.A. and Great Lakes Advisors, LLC, respectively. Investment prod- ucts such as stocks, bonds, and mutual funds are: NOT FDIC INSURED | NOT BANK GUARANTEED | MAY LOSE VALUE | NOT A DEPOSIT | NOT INSURED BY ANY FEDERAL GOVERN- MENT AGENCY.


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