After the beating they took in bonds over the last two years, investors can be forgiven for wondering if it was ever a good idea to rely on fixed income to lay up for old age.
New research validates these suspicions.
It’s a deeply out-of-consensus view certain to rankle the Wall Street establishment. A group of academics set out to test time-honored investing advice that says a diversified portfolio of bonds and stocks is the best way to save for the future. What they found across a sample of three dozen countries over 130 years was that a mix of half domestic, half international equities actually beat blended portfolios in both money made and capital preserved.
The paper, titled Beyond the Status Quo: A Critical Assessment of Lifecycle Investment Advice, adds fuel to an already heated debate after the 60/40 strategy misfired last year. With fixed income suffering subpar returns amid the Federal Reserve’s monetary tightening, some have argued traditional investing advice needs a rethink.
“As long as the equity investors are able to stick it out, they end up being better off with very high probability than somebody who’s trying to smooth out those short-term movements by diversifying into bonds,” says Scott Cederburg at University of Arizona, who co-authored the paper with Aizhan Anarkulova at Emory University and Michael S. O’Doherty at University of Missouri.
Using a computer to run a million simulations for American households, the researchers found that splitting money between domestic and international equities built just over $1 million of wealth on average by retirement, compared with $760,000 for the 60/40 mix. While the maximum loss for the all-stock approach was deeper, it wasn’t bad enough to derail performance over the long haul.
Several factors prevent advisers from grasping the advantages of an all-equity approach, one of them being overconfidence in the stocks-bond blend born of myopic focus on the short term, the authors say. Another issue is a lazy belief in the capacity of the two asset classes to balance one another. The researchers found periods in which they moved in unison are more common than people probably realize and that diversifying share holdings across geographies works better.
Data going back to before the start of the 20th century suggest that the failure to take full advantage of the upside in stocks means lost welfare estimated at $240 billion a year for one type of plan, says Cederburg, whose own retirement account recently held 44% US stocks and the rest overseas equities. (He owns bonds in a non-retirement account.) The study employed a lifetime model that incorporates real-world data on everything from American income to mortality and social security benefits.
Mixing stocks and bonds is the retirement strategy of choice for many Americans, often through so-called target-date funds offered by mutual funds. Such vehicles housed $1.8 trillion of assets in 2021, rising from $340 billion a decade earlier, according to data compiled by the Investment Company Institute.
To be sure, arguing that pension investors should shun bonds completely will strike many as extreme. It challenges a long held and widely followed practice where fixed income constitutes a pivotal part of the retirement pool for many Americans.