Retirement Investment: The Case for Equity Over Bonds Study Suggests

Research published in October 2023 suggests a significant shift in retirement investment strategies is merited. The research indicates that retirees often benefit more from an equity-focused portfolio rather than the traditional equity/bond split.

The Status Quo – Case For Equity Over Bonds

Titled “Beyond the Status Quo: A Critical Assessment of Lifecycle Investment Advice,” the study delves into data from 38 countries apparently spanning 130 years. Full report here.

The purpose of the study was to challenge traditional investment strategies such as including bonds, and that younger investors should hold a larger portion of equity and older investors a larger portion of bonds.

The findings are quite revealing: an all-equity portfolio, split evenly between US and non-US stocks, would typically amass an average of $1.07 million by retirement, surpassing the growth expected from a traditional 60:40 stock/bond mix.

The disparity becomes even more pronounced post-retirement. Those sticking with stocks through retirement are projected to see their portfolio burgeon to $3 million, whereas adherents to the 60:40 strategy might see around $1.3 million.

Households allocating 50% to domestic stocks and 50% to international stocks are less likely to exhaust their savings and more likely to leave a large inheritance.

Beyond the Status Quo: A Critical Assessment of Lifecycle Investment Advice.
Aizhan Anarkulova, Scott Cederburg, Michael S. O’Doherty

A Sense Of Balance

As you may have seen from our Pension ‘Lifestyling’ analysis recently ( Blog 241), investing in defensive assets over the long term is generally not conducive to favorable financial outcomes for us. While all these findings advocate for an equity-centric approach, it’s crucial to note that the most effective portfolio isn’t just about numbers; it’s about what affords you peace of mind and confidence.

The study acknowledges the psychological hurdles associated with an all-stock portfolio, particularly the distress caused by market fluctuations. Investors might feel tempted to abandon their investments during downturns. This can be a real concern for some, particularly given that both stocks and bonds can dip simultaneously, as we all witnessed in 2022.

However, it’s noteworthy that the study suggested that an all-equity approach significantly reduces the likelihood of depleting retirement funds. In essence, from a capital preservation perspective, it is lower risk than the ‘lower risk’ approach! Indeed, only 8% of simulations running dry before death, compared to 16% for the 60/40 Equity/Bond mix where you are drawing-down on the portfolio.

The Merits of Bonds

While bonds offer a psychological cushion, the study suggests that the comfort they provide might come at a substantial cost to potential future long term returns. This advice might resonate with investors who have a high tolerance for risk, and scare the day-lights out of those that have not!

How might Irish retirees consider this finding? Is it really worth considering equity Over bonds?

If you are invested in pension structures there is obviously no tax on any gains on assets within the scheme. And another consideration is that if you are drawing annual income from that pension pot in retirement, you will be subject to imputed distribution if you are 60 or over.

See Revenue Pensions Manual Chapter 28 here. Given equity value temporarily declines by 20% or more on average of every few years, you will need to be content to sell equity at a knock-down price, unless you have some defensive assets in the portfolio to act as a reservoir of cash. Bonds often fill that position in portfolios, and can be a valuable resource to have.

If non-pension, it’s essential to understand the tax implications of investing in stocks versus bonds. Ireland’s tax laws, including Capital Gains Tax and Dividend Withholding Tax, can influence the net returns from these investments. Furthermore, understanding the nuances of investing in global stocks, such as currency risk and geopolitical factors, is crucial for a well-rounded strategy.

Recent trends in Ireland’s pension landscape, including changes to the State Pension age, deferral options, and the introduction of auto-enrolment schemes also play a role in retirement planning for some.

Diversifying your portfolio with a mix of domestic and international assets, and possibly some defensive assets can provide a broader safety net against market volatility, aptitude to volatility, and income generating needs.

While the study advocates for a bold, equity-heavy approach which I’m broadly a fan of, individual circumstances, market understanding, and a keen awareness of one’s risk appetite are paramount. It’s not just about what you invest in, but how well it aligns with your personal financial journey, timings, needs and the broader economic environment.

All Equity or Mix of Bond – Pros and Cons

In Ireland, embracing an equity over bonds portfolio comes with its distinct advantages and challenges for retirees. On the plus side, an all-equity approach appears to often offer higher potential returns compared to an equity/bond approach, particularly relevant in the long-term perspective essential for retirement planning. 

However, the con is the volatility and imputed distribution. Equity are more likely to fall below the value you bought them for, which can be unnerving for retirees seeking stability in their ‘spending phase’, plus the demand to sell between 4 and 6% of the pot every year even if you don’t need it!

Final Thoughts – Equity Over Bonds

The choice between an all-equity portfolio and one that includes bonds or other defensive assets is deeply personal, hinging on your own risk tolerance, financial goals, timings, and the specific hopes.

Finally, Irish investors approaching retirement should consider consulting with an independent financial advisor to help tailor an investment strategy outside of their existing scheme that aligns with their risk tolerance, financial goals and need for long term accumulation.

I hope this helps.

Paddy Delaney QFA RPA APA

See Disclaimer re investment risk:

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