Should You Be Invested 100% Stocks Before and During Retirement? A Recent Study Says Yes
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Walking the 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 four sixty. Its title, should you be one hundred percent, invest in stocks before and during retirement? A recent study says, yes, a listening.

I recently sent me this paper. He said he was fascinated by IT and its implications. The papers, titled beyond the status quote, a critical assessment of life cycle investment advice, is by three coauthors in arco, va, setter, berg and adult.

They say they chAllenge two central tenets of life cycle investing. One, investors should diversify across stocks and bonds. They argue that should be one hundred percent stocks. The second is the Young should hold more stocks than old. They argue that these should still be one hundred percent invested in stocks.

They write an even mix of fifty percent domestic stocks and fifty percent international stocks held throughout one's lifetime vastly outperforms age based, stock based strategies in building wealth, supporting retirement consumption, preserving capital and generating request. That's some pretty startling conclusions. Will 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? We have the stomach to be a hundred percent stock despite the big draw wms, that can be seen. The authors in the paper point out that americans contribute about five percent of the total employee compensation to define contribution plans at a five hotter and eight six billion dollars and just twenty twenty.

The question they have is how should they invest those savings? And the authors share the the consensus wisdom from investing textbooks that the Young should be more heavily in stocks because they can stomach, they draw out and they have the human capital to overcome those losses, as they continue to say for retirement. Popular financial riders such as dave ramsey, suzor man, also share similar advice to have more in stocks when you're Younger, less when you're order and and diversity by having some income exposure.

Even the government, the federal government, through the pension protection act of two thousand six, says that investment plans to find 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 exposure. That's the consensus.

That's what's taught. That's what i've practice. That's what I have taught also a mix, a of stocks and not just bonds, but other asset classes to get diversification.

What these authors did though, as they build up a really interesting data set because many of the studies that look at what percent um the retirement mistakes should be spent during retirement, such as the four percent rule or investing for the long run, is based on U S. Data, U S. Stock data.

That's a problem because the sample size of major asset classes in the U. S. Is fairly small. The data generally only goes back to nineteen twenty five.

Most uh, the academics that that uses data of researchers, they get IT from the center for research and security Prices. And so if you're modeling, lets say, a monticola simulation of returns, you only get a few thirty years sample of stock returns using only the U. S.

Data also suffers from survival bias. We've discuss this an earlier episodes that the U. S. Has been extraordinary lucky.

If we look at the pricing of options to protect against the downside, put options IT IT appears that the U. S. Just hasn't had a lot of the bad things that have happened to other countries.

Trading halls for an extended period time where the stock market is closed, wars on their home territory that disrupted hyper inflation. Other extreme events, these are events that have impacted other countries but not the U. S. And so in for doing a study and saying for the long run and we only use U S.

Financial markets to determine that IT can be somewhat bias because how fortunate the s has been in the past and we're not entirely sure the s will be as lucky or fortunate looking out into the future. Particular were talking a fifty year time horizon for in stocks. What these authors did then is they build a database using thirty eight developed market countries, and so they have what effectively is thirty thousand specific monthly observation.

And the data covers from nineteen eighty to twenty nine. They focused on domestic stocks. International stocks, bonds and bills are a very short term government bonds. And they did what's called a bootstrap simulation.

They took ten year blocks of time, one hundred and twenty months, and they would sample from one of the countries for that ten year period of times so that there was consistency with how the stocks performed relative to the bonds, relative to effectively cash and even the experience of those local investors, what their returns would have been investing outside of that home country. They did many, many simulations, sampling from this data. And the reason they use thirty eight different countries is because those countries had different experiences, and they didn't suffer from the easy data effect.

So easy is to do a study, to grab the crisp data, do the study, but they actually do work to put together this database, and they use the same database, the same process, this block bootstrapping in the study on spending rates, which will also address in this episode. That's how they generated the returns. But they also looked at sample couples that had different life experiences.

Some were unemployed for a time and weren't able to contribute to their retirement, and they used a percent contribution rate. But if they made less than fifteen thousand hours and they didn't contribute that year in other way, they tried IT to generate a realistic tic life scenario of someone, a couple, entering the workforce at age twenty five, saving for forty years, experience ing a certain return stream. Are these assets then retiring at age sixty five, collecting social security, continuing to invest, spending the money down using the four percent spending rate, in that they spent four percent in the first year retirement.

And then IT was adjusted for inflation. But in their case, they were using since of using real numbers, net of inflation numbers, they will just keep that spending amount steady at four percent. And then they saw what happened, and they looked at the probability of retirement ruin running out of money.

And they based IT on different strategies, a traditional target date fund strategy that has a glide path where the amount and stocks drops over time. They used a traditional baLance approach, sixty percent stocks, forty percent bonds. They use in all equity approach, all domestic equity.

And they used fifty percent domestic stocks and fifty percent international stocks. So many, many different scenario. And they found that the stocks strategy that was invested, a hundred percent domestic socks throughout the life cycle generated thirty percent higher average retirement wealth than targeted.

And the strategy of fifty percent domestic and fifty percent international produce thirty two percent higher average retirement wealth. Now that should raise a red flag because stocks experience positive. Stevens, because stocks are volatile, there can be periods for stocks do very, very well. And as a result, because of those extreme events where things go very, very well, we'll see the average of a stock purfoy that ending wealth is brought up, that averages is in Price, are elevated because of the really good times that happened.

Where's most of the observations, including the medium, the middle will fall below the average because of the positive stuss will look at in the data and their tables or summary tables how we can see that positive stuns because we don't care about the average as investors. We care about ruin, how often that happens run out of money. And we care about the medium outcome, the fifty percent probability outcome.

They admit in their paper that the stocks strategy does have worse left tail outcomes, and although its retirement ruin then a target date fn that purely domestic hundred percent allocation to stocks, but being diversified internationally actually did Better in terms of the percent of retirement room. They found that retired couples using target date funds have a sixteen point nine percent probability running out of money retirement retirement run using the four percent spending rule, the one hundred percent domestic stock allocation had a seventeen point four percent probability retirement room, but surprisingly, the all stock, fifty percent domestic, fifty percent international, had retirement ruin of only eight point two percent, so much less now. The all stock portfolio had bigger draw dance during the the forty year accumulation phase and the the spending face the maximum drawed down for a domestic and international allocation was fifty percent versus a targeted strategy thirty eight percent.

We'll look at the the impact of this draw down on behavior and deciding whether we should pursue this or not. Let's take a closer look at the outcomes. They had eight scenario, and we want to go in the detail each one I mention, the target date fund the baLanced option, fifty percent stocks, domestic stocks, forty percent.

They had a baLance that included international to thirty percent stocks, domestics stocks, thirty percent international stocks, forty percent bonds. They had a couple of age based rules where the allocation to stocks decreased as the investor got older. They had a capital preservation strategy, one hundred percent in treasury bills, or a very, very short term government bonds.

And then they have the two equity strategies, one, one hundred percent domestic stocks. The other, fifty percent domestic, fifty percent international. As I mentioned, the allocation to all stocks had a higher average at the end of all the strategies, about twenty percent higher, the worst in terms of the amount of wealth.

And this is wealth that retirement was t bills, because that is, clearly they weren't earning as much. But the best outcomes, that ninety nine percent outcomes was the all stocks. Even the ninety five percent handily outperformed big benefit on extreme website.

We care about the fifty percent percent tio the media that fifty percent wasn't that different for the target date fund, for example, that the fifty percent tile among was point five eight, the all domestic stocks was point six two and the domestic and international stocks point seven three. That medium that fifty percent percent till wasn't that different in the twenty fifty percent till on the downside. So those observations that were worse than seventy five percent of the outcomes the targeted date actually did Better than the one hundred percent domestic stocks.

Some of the age base reducing the allocation did Better than one hundred percent stocks. But at the twenty five percent time where seventy five percent of the observations is Better, these domestic, international hundred percent did do Better point four zero versus the others target date fun was at point three three. So having that hundred percent stocks, including fifty percent of the stocks being international, did you Better than all the strategies, even some of the the worst case scenario? But what about the drawdown? Is clear that the higher allocation to stocks had bigger draw dots.

And what we don't know is when an investor faces those losses, how they will react. I know investors that have never returned to the stock market after losing money in the great financial crisis of two thousand eight, and that's the biggest chAllenge with a one hundred percent allocation to stocks. We don't know how we will react because we're not a money color simulation.

We get one shot as we proceed through time, and we don't know how we're gonna react. Will we have the fortitude to sit and recover those losses? If investors do at least based on this simulation, things like to work out just fine for the fifty percent domestic, fifty percent international allocation, but there's no guarantee that we would have the fortitude to not bail on the stocks.

Another table was what percent of the retirement income, but the earned income at retirement was replaced using the four percent rule, plus sosa security. And again, for the ninety fifty percent half example, that all stock purfoy listed measurably well than the other strategies. But we care about the media outcome because of positive skis.

And at the fifteen percent level, the target day fun wasn't that different. Then the hundred percent domestic stock allocation replacing about ninety three percent of preretirement income versus ninety six percent for domestic stocks and one hundred and five percent for the stocks. The domestic international combination.

Now the draw down during retirement, maximum draw down was much less for the target date fund at the fifty percent percent out level in that. And we would expect that because by that point, the investor has less in stocks. What about retirement? Ruin the the amount of wealth of death.

The medium was higher for having one hundred percent in stocks, including international stocks. But at the twenty fifty percent tile level, domestic stocks didn't necessarily perform any Better than the other strategies. The more diversification did do Better.

So when we we think about the study IT is true that one hundred percent stock portfolio, including having fifty percent in international stocks, does perform Better. IT does reduce the probability of ruin if we stick to the plan. Before we continue, let me pause and share some words from this week.

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The authors, and there is an additional co author released sort of a companion study focusing on retirement spending rates, trying to figure out what percent should investors spend in retirement. The consensus is the four percent rule. That's what's typically taught.

But again, most of those studies are based on U. S. data.

Their study, same data set, thirty eight developed countries twenty five hundred years. They point out, for example, the risk of using the U. S.

data. Japan experienced a real return of negative nine percent from the thirty year period from one thousand nine ninety to twenty and nineteen. There's no guarantee that our country, whether one lives, will do as well.

With fascinating about this paper was an investor in sixty percent domestic stocks, forty percent bonds, using the four percent rule. Retiring at age sixty five faced a seventeen point four percent chance. Retire, run.

Now, if he was just U. S. Dox, that percent was less, again, because of selection bias in the fact that the us. Has been fortuitous and not experiencing hyperinflation or war domestically. But if we brought out the data set, twenty five hundred years worth of data, thirty eight different countries, the probability of ruin ends up being seventeen percent.

And then they looked at, well, what should the spending rate be if we wanted to keep that probability of retirement room and running out of money at five percent or less? And the spending rate would be for sixty forty portfolio, two point two six percent. That's including their data set with thirty eight developed countries.

If we just use U. S. Sample, we're right there.

The four point two percent, one hundred percent stock p portfolio. The U. S. Sample, five percent risk of ruin, four percent spending rate.

If we use the broader data set, the more inclusive data set, the spending rate is only two percent to keep that probability of ruling less than five percent. Those are so bring. Now, even with their new data set, there are some potential problems with IT.

For example, they try to avoid some survival bias, but there are some countries that get drop from the database because longer developed. So shackle zao chia was only in their database for one hundred and twenty six and one hundred and forty five. I was there for nineteen, twenty seven and nine thousand, seventy argento, nineteen thousand and forty seven, nine thousand and ninety six.

Now they use classification once a country's labor share, that as an agriculture drop below fifty percent. Then I was added to to the database. And then after one thousand nine hundred forty eight, if they were added to the organization of economic CoOperation and development, O, E, C, D, they were added.

But then you had countries leave in so that that is a chAllenge with their approach. You have to decide to IT doesn't include emerging markets and IT assumes that what happened is what happened, but I didn't have to be that way. And that's the problem with with all of these historical studies.

Even if we get A A Better data set and this is and it's a data set that doesn't support a four percent spending rate in retirement, there are still some selection rules and some potential chAllenges that assumes that in the over those ten year period of time, that is using the blocks, that the correlations are constant, that the volatility is constant. There is a risk that, uh, maybe the block shouldn't have been ten years, maybe have been twenty years. There are some direction in terms of deciding, and there could have another extreme events that may have happened that just wasn't included in the dataset.

I think this is the best data that i've seen for these type of studies. But again, IT is a monticola simulation. IT isn't what we're going to experience going through time.

As we try to implement this, how will our behavior change? And and I thought about this over the break, because I read in the semicon tolb s first book, fold by randomness. IT came out in two thousand.

One, i've never read IT. I've read these other four books, black one was the first one I read. IT came out two thousand and seven in the completely changed, how I approach investing, my awareness of risk, how I thought about risk.

And I thought over the break, how would my investment career have defeated, had I discovered, fooled by andy ness in two thousand one, and recognize a investors track record is so short, you really can't make any conclusions. And some of the other behavioral things that are outlined in that book, and we don't really know how we will react with talib teachers and and another book i'm rereading, taliban former partner march picks nego. His book is safe haven investing is we want to eliminate these big drawdowns because of volatility, drag how difficult IT is to recoup not just behaviorally, but just mathematically.

And that if we can eliminate the big drawdowns, that will raise our portfolio return and allow us to have more n retirement. It's just figuring out how to do that into. I'm reading IT again because I spit snake doesn't go out and tell you this is the golden NASA class to do IT.

He teaches the methodology and i'm going through the math again to see is there way to protect against the downside in a cost effective way? Because if we can't reduce risk cost effectively, then we can have one hundred percent stocks unless we can live through these major journals. Now the conclusion of the two papers is international diversification helps, and many investors don't do IT.

There is still one hundred percent domestic stocks, or they have a token allocation, two, nine domestic stocks, ten percent, fifteen percent. These authors study supported that fifty percent allocation to international stocks. The rather conclusion is a lower spending rate is necessary in order to avoid retirement ruin.

Most people can afford to live in retirement spending two percent. So either after gamble or you buy an annuity and get that guaranteed income through that annuity, something we talked about numerous times on the show. Their study was also based on saving ten percent.

We can build a bigger buffer by saving more than that. And finally, recognize that there's always gna be a problem with the data. It's so even as much as we tried to clean up the data, there's just isn't enough data for the history of the k marker, particularly for one country.

This data sets Better, but this deal some selection bias in terms the data. And I wouldn't want to bet my retirement on this dataset even though the conclusion is you'll do Better the long term with a hundred percent diversified allocation to stocks, including international. I don't have the rist tolerance for IT, which is why I ve never been one hundred percent stocks.

I had more when I was Younger. But once I hieu financial dependence, part of which was also do to luck based on every. Turn series of a portfolio that I was managing.

Our team was managing. We did very, very well tracking client assets, great evaluation of our firm. And so I sold, but there was an element to luck with that in terms of the sequence of returns.

And so when I left the investment advisory business, i'm an incredibly risk verse ivester because I haven't found the way to protect against the downside with the high allocation, the stocks. So I don't have a high allocation stocks, about fifteen percent of my networks in stocks, common stocks. I have additional allocation to prefer stocks.

I have many different activities, which you can see my portfolio as a member of money for the rest was plus, and I share that every month. So be careful with studies and recognize we don't know whether the conditions in the future will be like the conditions in the past, and we don't know whether our behavior in the future will differ from our behavior in the past. And that's why I tend to be more conservative investor because I don't have the human capital to make up for a huge drawdown.

Where is Younger investors can. And so they should be and have a higher allocation to stocks, including international stocks. That episode four sixty, thanks for listening. You may be missing some of the best money for the rest of us content. Our weekly insider s guide email newsletter goes beyond what we cover in our podcast episodes and helps elevate your investment journey with information that works best in written and visual formats.

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