The Odds for a Retirement Nest Egg, Recalculated
NYTimes, April 20th, 2008
CONVENTIONAL wisdom recommends that investors start with a high
allocation of stock in their portfolios when they are young and reduce
it as they approach retirement.
That makes intuitive
sense: In your 20s, you may be inclined to take bigger risks; in your
60s, you may feel a greater need to protect the wealth you have been
able to amass.
But a recent study of real-world portfolio
returns, which fluctuate significantly from month to month and year to
year, has found that there is no particular advantage in this approach.
You would do just as well, with no greater odds of doing poorly, by
simply picking an allocation of stocks and bonds that you can live with
for a long while and sticking with it.
That is the implication
of “Hitting or Missing the Retirement Target: Comparing Contribution
and Asset Allocation Schemes of Simulated Portfolios,” by Harold J.
Schleef, an economics professor at Lewis & Clark College, and
Robert M. Eisinger, an associate professor of political science at that
institution. It was published last year in the Financial Services
Review, an academic journal.
The professors performed elaborate
computer simulations for hypothetical individuals investing for
retirement. Each earner is 35 years old and trying to amass $1 million
(in 2006 dollars) by age 65, in 30 years’ time. They differ in how they
divide their portfolios between stocks and bonds.
They also
differ in how the stock and bond markets perform during their decades
of investing. For each year and individual, the professors picked
randomly from the 80 years from 1926 to 2006. That means, for example,
that the period over which an investor is trying to amass wealth could
turn out to be like the 30 years beginning in 1929, a period when the
market barely beat inflation — or like the 30 years beginning in 1974,
a span when stocks provided stellar returns.
By running their
simulations thousands of times, and by assuming the future will be like
the past, the professors calculated the odds that any given strategy
would succeed. Consider, for example, an investor whose portfolio at
age 35 has 78 percent allocated to stocks and 22 percent to bonds, and
that the equity portion declines gradually so that, at age 65, it is
just 40 percent.
Such a scheme is typical of what many
financial planners recommend, and is similar to what has been adopted
by the so-called life-cycle funds, or target date maturity funds, that
mutual fund families in recent years have created. Assume further that
this investor contributes $11,000 each year to this portfolio. This
would be enough to enable it to reach $1 million by the time he is 65 —
provided the stock and bond markets each year perform exactly in line
with their long-term averages.
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