I just printed and read during my lunch break an interesting economics paper: Beyond the Status Quo: A Critical Assessment of Lifecycle Investment Advice, which is somewhat controversial and also recent (last updated this July).
My summary is that the authors' extensive simulations show a mixed 100% equities portfolio split between domestic / international is better for a long-term retirement scenario than 100% domestic, 60:40, or TDF (target-date-fund). Also the authors do not like cash and do not like bonds one bit.
A few select pull-quotes–on cash / equivalents:
- (in the years right around retirement) "The tactical cash allocation also does not provide meaningful economic benefits compared with maintaining full equity exposure."
- "Holding cash reserves in bills also provides little economic value. Consider a household that maintains an all-equity strategy with the same domestic-international split as the optimal age-based strategy. To gain the same expected utility over retirement consumption and bequest as a 10.00% savings rate in the optimal age-based strategy, the all-equity household would save 10.05%. Little is lost by investing exclusively in equity."
- "The tactical cash reserves in the age-based strategy lead to slight improvements relative to the fixed-weight strategy for ruin probability (6.7% versus 7.0%) and average retirement period drawdown (47% versus 48%), at the cost of a lower average bequest ($2.66 million versus $2.94 million)."
On international stocks vs TDFs:
- "International stocks better preserve real buying power (correlation with inflation of −0.01), as bonds suffer during inflationary periods (correlation of −0.78). In sum, bonds ultimately seem unattractive for long-horizon investors. They have low returns, high long-term variance, high long-term correlation with domestic stocks, and high exposure to inflationary periods."
- "We consider the simpler optimization problem of choosing fixed weights throughout the lifetime. The optimal fixed-weight policy of 33% domestic stocks, 67% international stocks, 0% bonds, and 0% bills closely mirrors the optimal age-based policy and achieves virtually the same expected utility, with a 10.07% equivalent savings rate relative to the baseline of 10.00%."
- "a couple must save 16.27% (i.e., 63% more) to achieve the same expected utility with the TDF"
On the exact portfolio composition (baseline is 10%):
- "All allocations ranging from 11% domestic and 89% international to 55% domestic and 45% international have equivalent savings rates below 10.50% (relative to the optimal fixed-weight strategy). This finding gives real-world investors considerable latitude in choosing equity strategies. For example, a US investor may feel comfortable investing over half of their wealth in the domestic market given the US’s large global weight. As long as investors avoid overly large domestic equity allocations, the utility costs are small even if they deviate from the optimum but remain invested in stocks. The welfare losses incurred by deviating from the optimal portfolio by adding fixed income, in contrast, are substantially greater."
They also posted the domestic to international smile, as expressed as necessary savings rate. and the same for bond/bill %ages:
Please note that the study was run for "developed countries" (including Japan, the UK, the US), the idea of US exceptionalism is addressed, and the goals for the study participants are to maintain their 4% retirements and not fall into ruin.
My main feedback point would be an interest in including other non-or-less correlated asset classes into the study, like commodities, gold, oil companies, managed futures, bitcoin or cryptocurrency, REITs, etc.
I am curious to know what people think and if they have any main critiques of the idea. I am personally feeling a bit of confirmation bias, because I dislike the idea of bonds as a long-term portfolio component.
by Sweet_AndFullOfGrace