Should retirees be 100% invested in equities?

[Marc]

I have a pension with Irish Life and am 7 years to retirement.
I noted today that I am now in 2 funds

Empower Growth Fund (Risk Rating 4)
Empower Stability Fund ( Risk Rating 2)

I am being "sheperded" into low risk funds the closer I get to retirement.

I will take an ARF self administered option when i retire so the above makes no sense.

Have been looking at putting 100% into their Indexed World Equity Fund (Risk Rating 6).

And problems with this approach that I may be missing?

I wrote this today in response to a post on linked in by David Blanchett

David Blanchett on LinkedIn: 100% stocks for retirement? A new study says dump the 60/40 portfolio and… | 31 comments

100% stocks for retirement? I’m a 100% meh on that one. There’s lots of research documenting the strong global historical performance of equities, especially… | 31 comments on LinkedIn

www.linkedin.com

A key takeaway for those at the point of retirement is really this

If you look backwards for the source of highest investment return you will absolutely conclude that long term you should be invested in equites and US equities in particular and really just US tech stocks.

So our naïve retiree lashes their entire retirement fund into Nvidia because it’s the best investment to have held recently.

That’s deliberately making the point that providing a retirement income for the whole of the rest of one’s life is not about seeking out the source of the highest historical return. We are all wise after the event.

In a forward looking retirement plan you are really liability matching (your future income needs) over an unknown future time period (your actual life)

To solve this puzzle we can make an educated guess about future investment returns which in the very short term will be wrong, probably very wrong but overtime we would expect to mean revert so eventually we will be approximately right.

We will also, on average, by definition be approximately right with life expectancy, but again could be out by a decade or so either side of that average in practice. There is no best before date on your birth certificate.

So in the same way that investors should operate on the working assumption that markets are probably efficient enough that in practice index investing will most likely prove to be the best strategy for their equity investments, despite the fact that some managers might beat the index; they are highly unlikely to invest with the lucky managers.

Retirees should also diversify their accounts and include (some) lower expected return bonds because the goal is not to end up with the highest inheritance for your children it’s really to not run out of money if the next 5 or 10 years turns out to be like the 1930s for equity markets and you are a forced seller of declining stock values.

Of course if you have other sources of guaranteed income and or can turn off the income distributions then you may reach a different conclusion.

But for those people who are relying on their retirement funds they need a reliable and predictable source of returns over both the long AND the short term. Bonds and by extension, annuities, fulfil that short term role better (not perfectly) but better than equities.

In other words, in the early years of retirement sequence of return risk and the NEED to provide an income every month, trumps long term capital appreciation and legacy planning.

In fact you might even conclude from this that at the point of retirement we should be invested close to 100% in cash and bonds to provide the confidence that we can retire right now TODAY but, counterintuitively perhaps, as we age we can afford to take more equity risk because we are moving closer to the bequest stage and have a shorter term need for income.

Just to expand one point further with examples.

If you are a Civil Servant with a defined benefit pension of €60k pa and you have some AVCs then yes, objectively, you have a very high capacity for loss. Arguably the AVCs are not “needed” for retirement income and were most likely accumulated because of the tax break.

So under those conditions a high equity allocation in an ARF is perfectly rational and sensible because the primary motivation most likely won’t be a predictable income.

If we contrast that with someone who has a typical defined contribution pension of say €150k to €200k then they also objectively lack capacity for loss and should be considering an annuity for some or perhaps all of the pension fund.

So the conclusion is that the retirement decision is extremely investor dependent and, ex-ante, you can’t ever make generalisations that you should always have an equity bias in your portfolio even if, ex-post, it turned out that you would have been lucky with the benefit of hindsight.

It may be generally true of some and maybe even most investors but it’s certainly not always true for all investors.

And that’s why retirement advice is so personal.

 

[SquirrelChaser]

I wrote this today in response to a post on linked in by David Blanchett

David Blanchett on LinkedIn: 100% stocks for retirement? A new study says dump the 60/40 portfolio and… | 31 comments

100% stocks for retirement? I’m a 100% meh on that one. There’s lots of research documenting the strong global historical performance of equities, especially… | 31 comments on LinkedIn

www.linkedin.com

A key takeaway for those at the point of retirement is really this

If you look backwards for the source of highest investment return you will absolutely conclude that long term you should be invested in equites and US equities in particular and really just US tech stocks.

So our naïve retiree lashes their entire retirement fund into Nvidia because it’s the best investment to have held recently.

That’s deliberately making the point that providing a retirement income for the whole of the rest of one’s life is not about seeking out the source of the highest historical return. We are all wise after the event.

In a forward looking retirement plan you are really liability matching (your future income needs) over an unknown future time period (your actual life)

To solve this puzzle we can make an educated guess about future investment returns which in the very short term will be wrong, probably very wrong but overtime we would expect to mean revert so eventually we will be approximately right.

We will also, on average, by definition be approximately right with life expectancy, but again could be out by a decade or so either side of that average in practice. There is no best before date on your birth certificate.

So in the same way that investors should operate on the working assumption that markets are probably efficient enough that in practice index investing will most likely prove to be the best strategy for their equity investments, despite the fact that some managers might beat the index; they are highly unlikely to invest with the lucky managers.

Retirees should also diversify their accounts and include (some) lower expected return bonds because the goal is not to end up with the highest inheritance for your children it’s really to not run out of money if the next 5 or 10 years turns out to be like the 1930s for equity markets and you are a forced seller of declining stock values.

Of course if you have other sources of guaranteed income and or can turn off the income distributions then you may reach a different conclusion.

But for those people who are relying on their retirement funds they need a reliable and predictable source of returns over both the long AND the short term. Bonds and by extension, annuities, fulfil that short term role better (not perfectly) but better than equities.

In other words, in the early years of retirement sequence of return risk and the NEED to provide an income every month, trumps long term capital appreciation and legacy planning.

In fact you might even conclude from this that at the point of retirement we should be invested close to 100% in cash and bonds to provide the confidence that we can retire right now TODAY but, counterintuitively perhaps, as we age we can afford to take more equity risk because we are moving closer to the bequest stage and have a shorter term need for income.

Just to expand one point further with examples.

If you are a Civil Servant with a defined benefit pension of €60k pa and you have some AVCs then yes, objectively, you have a very high capacity for loss. Arguably the AVCs are not “needed” for retirement income and were most likely accumulated because of the tax break.

So under those conditions a high equity allocation in an ARF is perfectly rational and sensible because the primary motivation most likely won’t be a predictable income.

If we contrast that with someone who has a typical defined contribution pension of say €150k to €200k then they also objectively lack capacity for loss and should be considering an annuity for some or perhaps all of the pension fund.

So the conclusion is that the retirement decision is extremely investor dependent and, ex-ante, you can’t ever make generalisations that you should always have an equity bias in your portfolio even if, ex-post, it turned out that you would have been lucky with the benefit of hindsight.

It may be generally true of some and maybe even most investors but it’s certainly not always true for all investors.

And that’s why retirement advice is so personal.

I see where you're coming from but i disagree.

First off: past performance isn't a reliable guide to future performance. BUT there's not really a more reliable guide available, so I'll take it.

It's true that the purpose of a retirement fund isn't to maximise the wealth you pass to your beneficiaries. But its also true that a side effect of the approach which maximises your sustainable retirement income also increases the probability of leaving a large pot to your beneficiaries.

I think the COAP gives a relatively decent income floor to retirees (especially those who own their own home, who are probably the vast majority of retirees with significant pension pots). So they can afford to accept a higher level of risk with their retirement funds.

I think the person with the average pension pot of say €200,000 and nothing else has more of a need to put their fund in equites to supplement their COAP than the person with a €60k defined benefit pension does.

Another factor is the ability to retire at all: for example, if i lifestyle my pension fund I've no hope of retiring before 65 or even later because I won't be able to afford to with any comfort. Thus leaving me with a much shorter as well as poorer retirement. I far prefer the possibility of a long and comfortable retirement to the certainty of a much shorter and more uncomfortable one.

There is an argument for holding a significant portion of the tax free lump sum as a hedge against a bad few years of equity returns. But really I'd favour spending a large portion of your wealth while young enough to enjoy it.

Ultimately it comes down to risk appetite as usual - certainty usually comes with a high cost in this context.

 

[Sarenco]

There seems to be a common view on AAM that equities will outperform fixed-income investments over any reasonable holding period.

It ain’t true…

Stocks for the long run?

It's commonly stated that stocks provide superior long-term returns to bonds. But what does "long-term" mean in this context? Over the last 20 years, the S&P500 has produced an annualised 4% return, with all dividends reinvested. That's an annualised real (after-inflation) return of less than...

www.askaboutmoney.com

And we haven’t even mentioned sequence of returns risk…

 

[conor_mc]

I see where you're coming from but i disagree.

First off: past performance isn't a reliable guide to future performance. BUT there's not really a more reliable guide available, so I'll take it.

It's true that the purpose of a retirement fund isn't to maximise the wealth you pass to your beneficiaries. But its also true that a side effect of the approach which maximises your sustainable retirement income also increases the probability of leaving a large pot to your beneficiaries.

I think the COAP gives a relatively decent income floor to retirees (especially those who own their own home, who are probably the vast majority of retirees with significant pension pots). So they can afford to accept a higher level of risk with their retirement funds.

I think the person with the average pension pot of say €200,000 and nothing else has more of a need to put their fund in equites to supplement their COAP than the person with a €60k defined benefit pension does.

Another factor is the ability to retire at all: for example, if i lifestyle my pension fund I've no hope of retiring before 65 or even later because I won't be able to afford to with any comfort. Thus leaving me with a much shorter as well as poorer retirement. I far prefer the possibility of a long and comfortable retirement to the certainty of a much shorter and more uncomfortable one.

There is an argument for holding a significant portion of the tax free lump sum as a hedge against a bad few years of equity returns. But really I'd favour spending a large portion of your wealth while young enough to enjoy it.

Ultimately it comes down to risk appetite as usual - certainty usually comes with a high cost in this context.

The answer seems to be somewhere in the middle according to Karsten Jeske.

“After all, the number one reason retirees run out of money is bad returns during the first few years of retirement. A low equity allocation shields you from short-term equity volatility, but longer-term you will need the high equity share to make it through 40, 50 or even 60 years of retirement.”

The Ultimate Guide to Safe Withdrawal Rates – Part 19: Equity Glidepaths in Retirement

The idea being to reduce exposure to equities early in retirement to maybe 60%, but gradually reintroduce them over the first 10 years or so to get back up to 80/90 or even 100%.

By the by, Jeske would be a contemporary of Wade Pfau, one of the authors of the paper that Marc referenced above.

 

[SquirrelChaser]

The answer seems to be somewhere in the middle according to Karsten Jeske.

“After all, the number one reason retirees run out of money is bad returns during the first few years of retirement. A low equity allocation shields you from short-term equity volatility, but longer-term you will need the high equity share to make it through 40, 50 or even 60 years of retirement.”

The Ultimate Guide to Safe Withdrawal Rates – Part 19: Equity Glidepaths in Retirement

The idea being to reduce exposure to equities early in retirement to maybe 60%, but gradually reintroduce them over the first 10 years or so to get back up to 80/90 or even 100%.

By the by, Jesse would be a contemporary of Wade Pfau, one of the authors of the paper that Marc referenced above.

Yeah, the middle ground is usually in many respects the best ground to stand on- i recognise that though I plan to skate around the edge myself.

The likelihood of me having a 60 year (or even 40 year) long retirement is regrettably low though...

 

[Dr Strangelove]

It ain’t true…

You made that post when interest rates were at their lowest in, well, the history of interest rates.

There was zero upside to holding bonds then. And I’m not saying that because risk-free bonds have fallen by approximately a quarter in value since then. I’d be saying that if rates were still as low.

Equities have basically unlimited upside. Bonds do not as there is an effective lower bound to rates.

 

[SquirrelChaser]

I’ll be sure to pass that on to my PI insurer

Fair enough, I'm looking at this stuff for myself rather than for a client so I'm digging into a lot more detail than you could give a client during a consultation because you simply wouldn't have the time.

I do think that the role of a professional advisor should be education on the options and risks if the various options. This wasn't my experience when setting up my pension initially, and honestly I'll be a lot better off in retirement for having done my own more thorough research later and acting according rather than sticking with the generic "advice to civil servant setting up an AVC" spiel I received.

BUT I think I also understand the difficulty of educating a client- during my own ancient history in conveyancing during the Celtic Tiger i always explained to people that the mortgage deed would be used to take their home if they defaulted and they'd still owe money if the house was sold for less than the mortgage- suffice to say that it gave me the long lasting belief that most people don't like knowing about the risks they're signing up to and much prefer others to do their thinking for them.

Also most people have never met a spreadsheet they liked, and don't seem capable of processing calculations more complex than basic arithmetic. And are also not amazing at long term planning outside of buying a home. Which makes the education part far more difficult obviously.

 

[Colm Fagan]

As many AAM readers know, I have strong views on ARF investment strategy and the dangers of sequence of return risk.
My personal ARF strategy from the start (December 2010) has been to invest everything in equities. Recent performance updates are here.
The record to date (30 November 2024 - almost 14 years) is that I withdrew 6% each year (total withdrawals to date exceed original investment) and the value of the remaining fund is more than double my original investment, meaning that withdrawals have also more than doubled.
Some contributors say that I was lucky with the timing. I agree. However, even if I weren't so lucky, I'm convinced it would still have been the right decision.
Let's look at some sample (deterministic) numbers to check the reasonableness of this assertion and also to explore the infamous bogeyman of "sequence of return risk".
Suppose someone starts with €2,000 in their ARF and withdraws €100 in year 1, increasing by 2% a year.
They have two investment options.
One is to invest in "bonds", earning a steady 4% a year (all figures are net of charges, etc.).
The other is to invest in "equities". The value falls by 15% in year 1 but thereafter increases by 8% a year. (For what it's worth, the worst annual fall for my ARF was slightly less than this; it happened in year 8). Suffering the fall in year 1 is the worst possible sequence of return risk.
The implied ERP of 4% a year is less than the average future ERP of 5.5% which a group of 1,756 economists expects (see footnote 1 of this paper). It's also about 8% a year less than my ARF delivered over the last 14 years, but as noted above I was lucky, and I would definitely not extrapolate that into the future; however, I would happily extrapolate an average expected equity outperformance of 4% a year into the future.
Under investment option 1, the money runs out at the start of year 27. There's just €50 left at the end of year 26. In contrast, under investment option 2, the fund value after 26 years is €2,100.
After 15 years (just beyond where I am now with my ARF, and I hope I still have a few years left in me), there is €1,327 of the initial €2,000 left in the ARF under investment option 1 versus €1,949 under option 2.

 

[conor_mc]

Thanks for sharing @Colm Fagan, and given the security blanket of state pensions in Ireland I’m inclined to agree with you.

However, the historic worst case scenario for US retirees is not the 1929 crash or the dotcom crash, it’s actually the Dec 1968 retiree cohort which suffered a long, slow bleed right through the stagflation of the 70’s until eventually the market took off again in the early 80’s. That was 15-odd years of anaemic growth and included three recessions, I think.

The question for anyone retiring now at these lofty equity valuations is whether to insulate against that worst case scenario or to cross fingers it doesn’t happen to you, but trust in the state pension to put a floor under the downside risk of running out of capital early if it does.

 

[Marc]

And just for balance here is the 14 year period for the USA from 1930

 

[Marc]

And here is the US market adjusted for inflation over the 20 years from 1930

 

[Marc]

And the 15 year period from 1970 again in real terms

 

[Marc]

Or if you had retired in 2000

 

[Duke of Marmalade]

And that’s why retirement advice is so personal.

I would slightly amend that to "the retirement decision" is very personal. But it is not rocket science. IMHO there is enough on this site to inform most people.
For people who would just about manage on a "safe" approach, the average risk premium is not sufficient compensation for them. The suggestion that they should take a punt anyway to at least give them a chance of a bit of luxury would I suggest not be chosen by many.
There are those who are well enough heeled that in effect they are deciding how best to invest their Estate. And if they're only marginally in that space then their beneficiaries would have a highly geared exposure to equities. Perhaps it should be a joint decision!

 

[conor_mc]

I would slightly amend that to "the retirement decision" is very personal. But it is not rocket science. IMHO there is enough on this site to inform most people.
For people who would just about manage on a "safe" approach, the average risk premium is not sufficient compensation for them. The suggestion that they should take a punt anyway to at least give them a chance of a bit of luxury would I suggest not be chosen by many.
There are those who are well enough heeled that in effect they are deciding how best to invest their inheritance. And if there only marginally in that space then their beneficiaries would have a highly geared exposure to equities. Perhaps it should be a joint decision!

I think you over-estimate most people. Most people will not even be aware of the existence of this site. Furthermore, I would say in most retiring couples there is one who does the finances and one who doesn’t, but the latter may outlive the first. I wouldn’t worry myself about a high, self-managed exposure to equities but I would worry about leaving the other half in that situation and would prefer her to have a larger element of fixed income than just her state pension if I predecease her (and odds are that I will!).

 

[SquirrelChaser]

The question for anyone retiring now at these lofty equity valuations is whether to insulate against that worst case scenario or to cross fingers it doesn’t happen to you, but trust in the state pension to put a floor under the downside risk of running out of capital early if it does.

I think anyone retiring now (maybe at any time) is foolish to look at the current value of their fund and actually believe that number.

My analysis suggests the average 20 year return of the Nasdaq 100 is about 11%. After almost 5 years, i calculate the annualised return on my Nasdaq 100 based pension fund is 20% so far.

I would be stupid to look at the current value of my fund and believe it. By my reckoning it's maybe 40% above the real value. I'm pretty certain it'll correct over the next 20 years.

If I was retiring now I'd be beyond stupid to spend my pension fund as if the current value were real  unless I was anyway getting out of equities.

Look at the long term trends of what you're investing in and apply them to your investments. If your investments are above the long term trend assume the portion representing the overvaluation will disappear over time. If they're below the long-term trends, assume they're real. Act accordingly.

With an almost full state pension and small but significant defined benefit pension I'll be able to take risks with my retirement investments. I'm not honestly sure I'd be so cavalier about it if my DB pension wasn't going to bump up my state pension by around 50%. I like to think I'd look at the numbers and go for it.

Investing in equites Is a risk. Spending money that shouldn't be in your fund is just stupid.

Edit- if you're had a good run to 70 plus and your fund is still running well ahead of the long term trend, go ahead and spend it. Sometimes you're just lucky and win big, so it's worth trying to spend it while you can!

 

[conor_mc]

Agree with above - when I said insulate yourself against that risk, I do mean the risk of your pensionable period being a) very long, and b) worse than the very worst that 100+ years of monthly retirement cohorts has ever experienced.

Again, highly recommend EarlyRetirementNow safe withdrawal rate series but he basically says what you’re saying except models it out using e.g. CAPE to represent over-/undervaluation.

 

[Marc]

I would slightly amend that to "the retirement decision" is very personal. But it is not rocket science. IMHO there is enough on this site to inform most people.
For people who would just about manage on a "safe" approach, the average risk premium is not sufficient compensation for them. The suggestion that they should take a punt anyway to at least give them a chance of a bit of luxury would I suggest not be chosen by many.
There are those who are well enough heeled that in effect they are deciding how best to invest their inheritance. And if there only marginally in that space then their beneficiaries would have a highly geared exposure to equities. Perhaps it should be a joint decision!

No I completely disagree. For some people it is too important a decision not to treat it as rocket science.

Just because you personally feel that you can figure this stuff out doesn’t mean that the population at large can, or should, try and figure this out for themselves.

 

[Duke of Marmalade]

No I completely disagree. For some people it is too important a decision not to treat it as rocket science.

Just because you personally feel that you can figure this stuff out doesn’t mean that the population at large can, or should, try and figure this out for themselves.

Marc take the proposed AE scheme. 99% will be defaulted into a strategy chosen by the DSP. From what I can glean the DSP do not envisage any need for punters to seek financial advice. As it happens I don't agree with the proposed default strategy and I presume a dozen financial "experts" would come up with a dozen alternatives.

 

[Colm Fagan]

Thanks everyone for the replies.
I found some of the comments fascinating in the context of my long-running quest to explain an investment phenomenon called the equity premium puzzle.
I'm not an expert on investment theory, but my understanding of the puzzle is that, historically, excess returns on equities over bonds are much higher than can be explained by behavioural economics, risk aversion, etc.
Various possible reasons have been advanced. My personal theory is that it is due to the activities of intermediaries in the market. Their payoff matrix is very different from the investor's payoff matrix.
To explain, take the example I quoted earlier (2000 investment, withdrawing 100 a year, increasing). My back-of-a fag-packet analysis (e.g., allowing for 15% fall in year 1, etc.) would give me, as an investor, sufficient comfort (if I thought values were reasonable in the first place - something I'll come back to). However, the almost universal response (above) was that it wouldn't be sufficient. Some of the reasons given were sound but some were dodgy.
I suspect that many of the respondents were financial advisers. They have a different payoff matrix. It's heavily biased towards avoiding the downside. If an adviser advises someone to invest in equities and they rise sharply in value, the investor is likely to give themselves most of the credit for their canny decision. It's only human nature. However, if the investment tanks, the investor is likely to blame their adviser, not themselves. Again, it's only human nature. Therefore, the best counsel for the adviser is to err very much on the cautious side. That was the general response above. This causes the equity risk premium to be higher than it should be if everyone was completely rational.
For what it's worth, I agree that (from my limited analysis) many leading US stocks are very overvalued currently. Unfortunately, though, far too many of the stocks in my own portfolio are undervalued (and sadly have been for years!!!) so I'm not getting out of the market into cash.