There are principles in finance that are rarely, if ever, questioned.
For example: an investment portfolio must contain at least two asset classes: stocks and bonds.
Also: young people must have a high proportion of stocks in their portfolio. With age, we increase the percentage allocated to bonds, so as not to be forced to sell stocks during a market drop in retirement.
I myself adhere to this way of seeing things, and I share it with you here with disturbing regularity.
So I was surprised by a new study which shows that this approach is far from being the one that has generated the most wealth for investors.
Titled “Beyond the Status Quo: A Critical Assessment of Lifecycle Investment Advice,” the study was carried out by researchers from the University of Arizona, Emory University and the University of Missouri.
Consult the study (in English)
The researchers wanted to know what proportion of stocks/bonds offered the best returns throughout people’s lives, from the early stages of their careers to the final years of their retirement, sometimes 70 or 75 years later.
To achieve this, they analyzed the stock markets of 38 developed countries from 1890 to 2019, almost 130 years of data. This includes terrifying events like two world wars, the crash of 1929, the Great Depression, the September 11 attacks, the Quebec tram debate, etc.
Bottom line: the best approach to accumulating investments during your working life, living for decades in retirement and leaving money as an inheritance to your children is to have 100% of your assets in the stock market, and to avoid completely the obligations.
The reason is simple: during the periods analyzed – almost 2,500 years of data when put together – stocks have generally generated four times more wealth after inflation than bonds.
Researchers found that investors who had an increasing percentage of bonds in their portfolio as they aged had to save 40% more money during their working lives to expect to have the same standard of living in retirement as 100% investors. actions.
The most interesting thing is that when disbursing in retirement using the often used 4% rule (selling 4% of your investments per year while adjusting the amount disbursed each year to cover inflation), investors 100% Stocks were less likely to run out of money than investors with bonds. This is because they have accumulated much more wealth over the years, so their purchasing power remains higher, even with falls.
“It surprised us,” Scott Cederburg, associate professor of finance at the University of Arizona and co-author of the study, explains to me in an interview. We often hear that bonds are a safe haven for retirees. On the contrary, we see that the risk of inflation during retirement and the possibility of a long life make bonds unattractive for retirees. »
As for the composition of the portfolio, researchers have calculated that, for a country like Canada, the ideal weighting is approximately 35% for a Canadian equity fund, and 65% for an international equity fund.
“So there is a bias in favor of the country of origin,” notes Mr. Cederburg. And exposure to international stocks is not hedged against exchange rate risk. In fact, it has been found that in the long term, exchange rate fluctuations offset inflation risks in the investors’ home country. »
OK but…
Before you rush to change the composition of your portfolio, a little thought is in order.
First, the best data and the best studies can only tell us about the past. The past is not necessarily a guarantee of the future. Bonds have just had a terrible decade. I wouldn’t be surprised if the coming decade is better for bonds.
Then, the disadvantage of a 100% equity portfolio is of course that it regularly puts our guts under a steamroller.
A portfolio whose percentage of bonds increases until it forms the majority of assets at retirement will statistically experience a drop of 38% during its worst moment, the researchers calculated. This drop will be 50% for a portfolio composed of 100% stocks.
I hear you thinking: “The difference is not huge. I can tolerate that! »
This is where I blow your mind. Very few people can withstand a 50% drop without intervening in their investments.
Remember: a fall is not experienced as a percentage. It is seen in dollars.
Seeing $18,000 in investments drop to $9,000 is probably barely bearable for the majority of people. But seeing $500,000 accumulated for retirement melt away for years, reaching $250,000… and doing nothing? Not selling anything to stop the noise in our heads, or to reassure our spouse who is on the verge of tearing it away from us?
I spoke with financial author Andrew Hallam, who is behind several international bestsellers, including Libra: How to Invest and Spend for Happiness, Health and Wealth And Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School.
“I think the distribution has to be individual, and it’s best for most people to err on the side of caution,” he says. Almost everyone overestimates their tolerance for volatility. »
Analyzes have shown that the higher the proportion of stocks people have in their portfolio, the more they tend to underperform their own funds. For what ? Because they can’t help but try to time themselves with the market, buy and sell at the wrong time, etc.
We often believe that it is young investors who speculate. But research has shown that it’s mostly older investors who can’t help but try to time themselves with the markets. They see the value of their investments decreasing, and sell to “preserve their purchasing power”.
But as increases in the stock market come without warning, this reduces returns.
“Studies on optimal yields are based on mathematical formulas,” says Andrew Hallam. They don’t take emotions into account. It is not the funds we possess that enrich us. This is how we behave with these funds. »
I think this study has the merit of reminding us that seeking stability at all costs in our investments is not desirable – even as we get older. Many people associate caution with safety. But what security does an extra prudent portfolio offer that is quickly overtaken by inflation?
At the same time, you need to know yourself well as an investor before embarking on 100% equity investments. Otherwise, the market could take care of our education.
As the saying goes: there is no age to learn.
You are green
Last week, I asked you what you were doing to reduce your carbon footprint. Your numerous responses surprised me; it’s easy to think that no one stops to think about the environment.
Julie writes that she bought a used electric car. “I work remotely 80% of the time, and the few times I go to the office (Laval – Old Montreal), I go 100% by public transportation,” she says.
Gilles writes: “I drive three times less than before, and I walk three times more than last year! I added a blanket to my bed, and at night I reduce the heat in the condo to 18 degrees. »
Food is also a concern. “We have greatly reduced our consumption of red meat,” writes Chantal. Once a week we eat vegetarian. One step at a time, we’ll get there! »
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