informed decisions blog

Risk of Ruin…Lifestyle & Default Investment Pension Strategies. Blog249

29th April 2024

Paddy Delaney

In Blog 241 in February this year I shared my analysis of Lifestyle and Default Investment strategies for pension funds in Ireland. The results, even over the recent decade of market appreciation, were not good for pension investors who choose the ‘Do It For Me’ approach to investing their pension pots, instead of the ‘Do It Myself’ approach and choosing mostly equity over defensive assets.

This was very similar to my findings that I shared in Blog 53 (almost 7 years ago!). My conclusion in that piece was “..Life-Styling, while reducing your volatility as you approach retirement, will potentially rob you of much of the gains to be had by investing in the first place…”.

For the past 7 years, I have been making the case for avoiding Lifestyling for most investors (those that can handle volatility). And it’s been a lonely place! While I had nothing but positive feedback from investors regarding these pieces – there was been little if any coverage of it from anyone else. Was I mad, or missing something? It appears not.

Beyond The Status Quo

A deep-dive white paper titled ‘Beyond the Status Quo: A Critical Assessment of Lifecycle Investment Advice’ was published at the end of last year – and it does a heck of a job in analytically back-testing Lifecycle (as they call it) versus other strategies.

In the hope that it might get some momentum going on challenge the narrative that one must reduce risk as they approach and enter retirement years with Lifestyle and Default Investment strategies, I am sharing the piece and it’s findings.

Full paper here, but here is how they approached it:

  • Simulation follows the lifecycle of a US couple (female and male) saving during working years and consuming during retirement
  • Adoption of a lifetime portfolio strategy for retirement investment (they didn’t buy annuity)
  • Savings start at age 25, with uncertain labor income modeled using researched age-based earnings model
  • Retirement at age 65, starting to receive Social Security income and withdrawing savings with constant real withdrawals using the 4% rule (so if you retire with €1m, year 1 income is 40k, increasing with inflation each year thereafter).
  • Longevity modeled using real US mortality tables, leaving an inheritance upon the passing of the last spouse.
  • Their research assessed four asset allocation strategies:
  • 1) Representative Target Date Fund (TDF) strategy (mimic your Lifestyle strategy in that they move from Equity to Defensive assets as you approach retirement – and stay there throughout retirement. See here for an example, Vanguard’s 2030 Retirement Date Fund which is c50% Bonds and 50% Equity as it is c6years out from an investors proposed retirement year.
  • 2) 100% government bills/bonds strategy (mimic a money market fund – which are currently doing well but over long term lag most everything!)
  • 3) 100% US stocks strategy. This has usually been good long term – but tends to be very crashy and lags rest of world pretty consistently when things are not going well, as we shared last week
  • 4) 50% US stock and 50% non-US stocks strategy – more akin to what we would recommend to an investor, globally diversified, and not reliant on any one country, region or industry for your long term success.
  • For each strategy they measured the level of wealth at retirement, the level of income generated at retirement, the probability of running out of money in retirement, and the level of wealth that each strategy left to beneficiaries at death. It was pretty comprehensive!

Here were the findings, which may or may not surprise you!

Wealth At Retirement:

No major surprises here for Informed Decisions readers; the table below shows the 50% US/ 50% non-US Stock approach delivered better outcomes at retirement across the million backtest scenarios the researchers completed. Those investors achieved a pension pot of c€1.07m at retirement versus a Mean of €810k for those using a Money Market Fund approach and €820k for those in a Lifestyle approach.

1-0 to Diversified Equity!

Retirement Income:

If you retire with a larger pot, and all pots were set to send you 4% of the pot value, the bigger the pot you have, the larger the income you would get in the research. So the Diversified Stock approach trumped all others here too – including the US only stock approach over the long term of the analysis.

2-0 Diversified Equity Approach

Wealth At Death

If you have a larger pot at retirement, and you also have a larger income in retirement, did the research also show that you’d have a larger pot at death too? Yes!

Real wealth at death of the Diversified Stock approach was €2.97m

Real wealth at death of the Lifestyle approach was c€1.2m

3-0 Diversified Equity Approach

Risk Of Ruin

The best till last. The risk of ruin is noted in the final column above, and is the risk of running out of retirement savings from each of the strategies.

From highest to lowest risk of each of the 4 main approaches:

Highest Risk – 100% Bills/Bonds: 35%

High Risk – 100% US Stocks: 17%

Lower Risk – Target Date Funds: 16.9%

Lower Risk – Lifestyle Funds: c15%

Lowest Risk – Diversified Equity: c8%

Investing in US Stocks or Lifestyle approach say you have double the risk of your pension pot running out in retirement versus a globally diversified equity portfolio. Wow!

4-0 Globally Diversified Equity Approach

What Should We Make Of All This? Lifestyle and Default Investment Strategies

This is really great quantitative data to have, and here are my thoughts on what it might get us to consider, discuss and explore further.

  • is it sufficient to aid conservative or mis-informed investors to consider exiting dangerous middle of the road default or lifestyle investment strategies? Maybe some will see the light – particularly the more analytically-minded!
  • Does it suggest that you are better-off not have any Bonds/MMFs in your portfolio? The data would suggest you should have 100% equity in everyone’s portfolio, no matter what age or stage of lifecycle they are at! Our preference, on the basis of the Irish model is to have an allocation to defensive assets that we can turn to for a few years income, particularly where we are obliged to draw 4/5/6% of the pot each year once investor is over 60! Bonds will drag on performance, that is clear and obvious, and many will still feel that the flexibility and reservoir in a prolonged market draw-down make them worthwhile
  • In order to benefit from the long term positive effects of an all-equity approach, you need to be able to stomach the latter severe and sometimes prolonged declines, which can and do happen! Not everyone is comfortable seeing their portfolio value falling from €2m to €1m, and leaving things as they are, to recover. They have always recovered, they have never not recovered to all new highs. Yet most will blow themselves up financially and move the €1m into cash or some such madness, and try to time their re-risk/re-investment into equity
  • You also need to be OK with certain countries within your portfolio not going well! If US is crashing and rest of the world is going OK, or vice versa, you didn’t mess around with the portfolio, you stuck with it. Not many can do that – and that’s where a professional advisor can be worth their weight – they are the gatekeeper between your fear and you messing with your portfolio!
  • Lifestyling is generally rubbish, and if investors only knew the reality, they wouldn’t opt for it. It is quick and easy to sell to uneducated investors, and I’m sure that’s the only reason it is so prevalent.
  • The data is based on historical returns and not future returns, the future can and will be different – but will these trends differ over the future decades? I doubt it personally.
  • The approach that many deem to be highest risk (whatever they mean when they say that is anyone’s guess) is actually the approach that has delivered bigger pots at retirement, bigger income in retirement, lowest risk of ruin and largest legacy for your loved-ones.
  • Common sense is not common

Please share this with someone you care about – and someone you feel may be walking into a higher risk of financial ruin – it could be the difference between them avoiding it or not.

Paddy Delaney



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