Living On A Permanent ETF Portfolio (2024)

What Constitutes An Ideal Permanent Portfolio?

Conceptually speaking, most people would define an ideal retirement portfolio as one that allows them to live in relative comfort after they quit the working world. A portfolio should always contain the appropriate balance of growth, income, and capital preservation. Thus, an ideal permanent portfolio focuses more on income and capital preservation than growth.

This time, I want to discuss constructing a lifetime portfolio, one that you can hold for the rest of your life without much active management. Probably the sole effort you put in is to rebalance the portfolio annually.

When you reach retirement age, learning how to invest may not be a favorite way to spend free time. With a plethora of ETFs drumming up, you may find the exercise exhausting. That’s why so many retirees stick to index funds. With the benefits of instant diversification, low-cost, and well-balanced, you can create a perfectly decent retirement portfolio with just two index funds: a total U.S. stock market index fund and a total U.S. bond market index fund.

In this regard, I have studied six funds in an earlier article named “Constructing a Safe and Profitable Portfolio” that was published in Seeking Alpha. If you find them a bit behind your expectation in diversification, consider this five-ETF portfolio.

My Five-ETF Portfolio

The constituent components are devised in such a way as to earn steady income all year round. They cover basic daily needs and services that are essential for existence, not merely for the sake of a comfortable lifestyle. Growth is not our concern in the selection of component ETFs.

Morningstar Style Box

Morningstar style box identifies a fund's investment focus based on a 3X3 grid. The vertical grid denotes the capitalization of the funds, while the horizontal grid denotes their valuation. Thus, according to Morningstar’s classification, they look like this:

Performing Statistics

(Source: Author’s analysis via Portfolio Visualizer)

The above table records the performance of individual ETFs in the portfolio. In the span of ten years since 2011, each ETF has appreciated at least 3X. If you split your fund evenly to each of them to form a portfolio, its growth curve will look like this:

(Source: Author’s analysis via Portfolio Visualizer)

This chart is plotted on the assumption that 20% is allocated to each component ETF. Besides, there were no cash withdrawals during the course of its growth. It started in January 2011 at $1,000,000 and finished by October 2021 with a balance of $3,839,473.

Your Income Portfolio

If you treat it as a retirement portfolio whereby you are to withdraw cash flow from it regularly, the appreciating strength of the portfolio shall slacken. You will soon realize that even at a 10% rate of taking out cash flow from it annually, the portfolio still grows. At no time had its value fallen below the initial capital of $1,000,000.

Of course, retirees can vary the withdrawal rate according to their spending needs. They can do this at 6% — 10% or anything in between. Here I present the dollar equivalents for each fixed rate of withdrawal from the portfolio:

(Source: Author’s analysis via Portfolio Visualizer)

On the presumption that an investor retired in January 2011 and joined this plan, he had the flexibility of choice in picking a column that fits his spending style. Due to the possibility of a rising trend in market volatility, I won’t recommend anything more than 10%. It’s wise to leave a certain margin that allows a portfolio to grow, albeit at a small pace.

Only in rare circ*mstances when the market performs extremely well will a retiree attempt to cash out more than 10%. This happened in 2013 and 2019 when the portfolio earned 23.34% and 27.09% returns respectively.

The last row of the above table is important in telling if the portfolio remains healthy after a continual withdrawal of funds. It records the portfolio balance after ten years of operation. The more cash flow you take out, the less growth the portfolio proceeds.

Make sure one crucial point: the portfolio balance must always be above its initial capitalization. Should it trespass its initial capitalization from above, it becomes a decaying portfolio that might not sustain continual cash flow. It might be due to an unexpected market shock. When this happens, stop any deflating actions and give your portfolio enough revival time until the market stabilizes.

(Source: Author’s analysis via Excel spreadsheet)

One interesting fact about the dollar equivalents of picking a fixed rate of cash flow is that they tend to converge to a point on the chart. Yes, the separation between them will narrow out but it won’t vanish. They will flatten out ultimately.

Portfolio Management

(Source: Author’s analysis via Portfolio Visualizer)

The above is a chart depicting the growth curve of the retirement portfolio when a fixed 8% cash flow is discharged from it yearly. Its trajectory looks choppy. It ought to be so because cash flow resembles much of a market shock. It started in January 2011 at $1,000,000 and finished by October 2021 with a balance of $1,667,823.

By the end of the year, investors shall collect dividends from the portfolio. A retiree opting for annual cash flow may need to sell a portion of the holdings to make up the difference. The principle is to maintain an equal weight among the five ETFs so that each constitutes 20% of the updated capitalization. This action is expected to go once a year.

In choosing the metric for cash flow, fix it in percentages rather than dollar amounts. Inflation shall be compensated for by the growth of the portfolio. Interfere with your portfolio as infrequently as possible. To protect your portfolio from dwindling, avoid monthly or quarterly withdrawals.

Study this chart and you will understand the demerit of the monthly cash flow concept. You joined this plan in January 2011 and started taking out cash from it a month after. The cash flow was $9,400/month, which amounted to $112,800/year. What would happen then?

(Source: Author’s analysis via Portfolio Visualizer)

Let’s go back ten years. You matched this $112,800 with the dollar equivalents of the 10% column in the cash flow table and found that they were very close in nominal terms. You were quite satisfied with the arrangement as you were living the lifestyle you had wanted. You had no desire to switch to an annual cash flow plan. You thought it made no difference between living on a $9,400 monthly plan or a 10% annual plan,

Time passes swiftly to 2021. It’s an apt time to make a judgment if you had made a good decision. The $9,400 monthly plan has accrued an unrealized profit of $79,622 (=$1,079,622－$1,000,000) by October 2021. Not too bad. But is it? You should have more profit than that had you used the 10% annual plan. A simple calculation shows that the unrealized profit can reach $338,741 (=$1,338,741－$1,000,000) had you adopted the 10% annual plan on the very first occasion. That’s a ratio of 1:4.

There is another pitfall that retirees must concern about. Don’t let your portfolio slip below its initial capitalization. According to the above chart, you got drowned three times. That is, your portfolio submerged below its initial capitalization of $1,000,000 on three occasions. If it failed to revive, it has a big chance of collapse. Thus to play safe, avoid all monthly or quarterly withdrawal plans.

One last comment: If you can afford a smaller income in the early years of retirement, execute stepwise by starting at 6% the first year, then 7% the second year, and proceed on until 10% the fifth year. After that, stay at the 10% rate to the end.

Man Yin To