The pros and cons of investing your retirement assets 100% in equity, including half in international stocks. Why the 4% spending rule is too aggressive.
Topics covered include:
- Why historical asset class return studies that use only U.S. data are biased
- How researchers build a broader database to study retirement outcomes and spending rates
- How a 100% stock portfolio performed compared to balanced portfolios and target date funds
- Why investors should have half their assets in international stocks
- Why a 4% spending rule is too high, and what is the alternative
Show Notes
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Transcript
Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is episode 460. It’s titled “Should You be 100% Invested in Stocks Before and During Retirement?” A recent study says yes.
A listener recently sent me this paper. He said he was fascinated by it and its implications. That paper’s titled “Beyond the Status Quo: A Critical Assessment of Lifecycle Investment Advice.” It’s by three co-authors: Anarkulova, Cederburg and O’Doherty. They say they challenge two central tenets of lifecycle investing. One, investors should diversify across stocks and bonds. They argue it should be 100% stocks. The second is the young should hold more stocks than old. They argue that retirees should still be 100% invested in stocks.
They write “An even mix of 50% domestic stocks and 50% international stocks held throughout one’s lifetime vastly outperforms age-based, stock-based strategies in building wealth, supporting retirement consumption, preserving capital and generating bequest.” That’s some pretty startling conclusions.
We’ll take a look at this paper, as well as a second paper by the same authors, that looks at the spending rate, to see if this is something that we should actually do. Can we do it? Do we have the stomach to be 100% in stocks, despite the big drawdowns that can be seen?
Saving For Retirement
The authors in the paper point out that Americans contribute about 5% of their total employee compensation to defined contribution plans. That’s $586 billion in just 2020. A big question they have is “How should they invest those savings?” And the authors share the consensus wisdom from investing textbooks, that the young should be more heavily invested in stocks, because they can stomach the drawdowns, and they have the human capital to overcome those losses as they continue to save for retirement.
Popular financial writers such as Dave Ramsey, Suze Orman also share similar advice, to have more in stocks when you’re younger, less when you’re older, and diversify by having some fixed income exposure.
Even the government, the federal government, through the Pension Protection Act of 2006, says that investment plans, defined contribution plans should have a qualified default investment alternative; what the participants are invested in if they don’t choose any of the options. And they say that that default option should provide long-term appreciation and capital preservation through a mix of equity and fixed income exposures. That’s the consensus. That’s what’s taught. That’s what I’ve practiced. That’s what I have taught also. A mix of stocks, and—not just bonds, but other asset classes to get diversification.
An Interesting Data Set
What these authors did though is they built a really interesting data set, because many of the studies that look at what percent of the retirement nest egg should be spent during retirement, such as the 4% rule, or investing for the long run, is based on US data, US stock data. That’s a problem.
Because the sample size of major asset classes in the US is fairly small. The data generally only goes back to 1925. Most of the academics that use this data, the researchers, they get it from the Center for Research and Security Prices. And so if you’re modeling, let’s say, a Monte Carlo simulation of returns, you only get a few 30-year sample of stock returns.
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