By Kit Lancaster, CFP® | Sterling Edge Financial
Picture this.
It’s January of 2000. You’ve just retired with $1.8 million—more than enough, you believe, to enjoy a 30-year retirement with dignity and adventure. Like many investors, you’ve built your nest egg around what you know: U.S. stocks. Specifically, 75% in the S&P 500 and 25% in the fast-growing NASDAQ.
Your plan? Withdraw 5% annually—about $90,000—to support your lifestyle, adjusting for inflation over time.
But by 2015—just 15 years in—your portfolio is completely gone.
Meanwhile, your friend and colleague—same age, same start, same withdrawal plan—invested in a diversified Dimensional portfolio. By 2025, they have over $4.5 million. How did this happen?
Let’s walk through it.
Understanding Diversification: More Than a Buzzword
Diversification isn’t just about “owning a lot of stocks.” It’s about owning a lot of different kinds of assets that behave differently over time. When one zigzags down, another may zag upward—or at least not fall as far.
A truly diversified portfolio might include:
- U.S. large-cap and small-cap stocks
- International stocks, including emerging markets
- Bonds and short-term fixed income
- Real estate investment trusts (REITs)
- Factor-based funds (value, profitability, small-cap, etc.)
Why does this matter? Because the future is unknowable, and history has proven that what worked yesterday may not work tomorrow.
The Dimensional Difference: Beyond the S&P 500
Let’s clear up a common misconception: the S&P 500 is not a diversified portfolio. It’s a concentrated collection of the 500 largest U.S. companies, dominated by tech and other high-growth sectors.
Dimensional’s factor-based portfolios, in contrast, are built on decades of academic research. They tilt toward proven drivers of long-term returns:
- Small-cap companies: historically more volatile but higher-returning
- Value stocks: lower-priced, more resilient in downturns
- High-profitability firms: better cash flow, stronger fundamentals
These portfolios are globally diversified, rebalanced regularly, and strategically exposed to segments of the market most investors ignore—until it’s too late.
The Hidden Threat: Sequence-of-Returns Risk
Retirees face a unique enemy: sequence risk. That’s the danger of receiving poor market returns in the early years of retirement, when you’re beginning to withdraw from your portfolio.
In the 2000s, markets crashed twice:
- Dot-com bubble (2000–2002): NASDAQ fell 78%. S&P 500 dropped 49%.
- Global financial crisis (2008): S&P fell another 42%.
If you’re pulling money out during these drawdowns, it’s like trying to bail water out of a sinking boat with a hole in the bottom. The account balance drops fast—and may never recover.
In our story, the NASDAQ/S&P portfolio depleted entirely by 2015. Inflation-adjusted withdrawals became unsustainable. Conversely, the diversified Dimensional portfolio not only preserved wealth, it tripled it—even while making the same withdrawals.
The Emotional Reality of Running Out
Imagine being 72, needing to cut your spending by half, or move in with family, or sell your home. This is not hypothetical—many retirees have lived this.
Diversification isn’t just about money—it’s about freedom. It’s about protecting your ability to say “yes” to your grandchildren, to travel, to enjoy the fruits of your labor.
What You Can Do Today
- Review your portfolio’s true diversification
- Are you really spread across asset classes, or just across different flavors of the same thing?
- Consider exposure to factors
- Academic research (and real-world outcomes) support investing in small-cap, value, and high-profitability companies globally.
- Manage sequence risk
- Tools like dynamic withdrawal strategies, bond buffers, and diversified income sources can significantly reduce risk in early retirement.
- Get a second opinion
- A fiduciary financial advisor can help you test your plan against multiple market scenarios. Don’t go it alone.
The Bottom Line
“Concentration builds wealth. Diversification preserves it.” — Michael Kitces
If you’re still heavily invested in a handful of large-cap tech stocks or chasing past performance, it’s time to pause and reflect. You can’t control markets, but you can control how you invest.
The retiree from 2000 didn’t fail because of bad luck—they failed because they didn’t diversify.
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