Introduction
In his 1994 paper, retirement researcher Bill Bengen determined that a portfolio containing between 50%-75% equities (shares) was optimal for helping provide a sustainable income over a 30-year period. In more recent times, some have advocated that a 100% equity retirement portfolio is a superior option, we assume, because equities tend to outperform bonds over the long term (this is up for debate, but that's a conversation for another day!), and this, therefore, makes for a more sustainable retirement income.
In this article, we attempt to determine what is best for a retiree, or maybe (as with many topics in retirement planning) it's not always black and white.
Recreating Bill's work
Let's start by attempting to recreate Bill's work. Bill used U.S. large-cap equities and intermediate-term bonds for his work. The closest we will get regarding asset allocation is as shown below, which we think is a reasonable starting point.
We will have a starting portfolio of £1,000,000 and withdraw an inflation-adjusted 4% yearly over a 30-year retirement.
For this 50% equity/50% bond portfolio, the safe withdrawal rate (SWR) is 3.27%. SWR means the minimum amount you could have withdrawn from a portfolio over a 30-year retirement without running out of money. It's effectively the worst-case scenario, and for this scenario, it would've happened if the retiree had finished work in the late 1960s, as indicated by the red line in the chart below.
Up the equity content of the portfolio to 75%, and the SWR increases slightly to 3.29%
Finally, the equity content is increased to 100%, and the SWR falls to 3.18%.
Bill was right, or was he?
A more diversified approach
Bill's analysis was focused on just the U.S. market. What if we introduce a more global approach?
Let's start with a 60% developed market (global in the screenshot below means only developed and not emerging markets) and a 40% global bond portfolio.
For this portfolio, the SWR is 3.58% (I'm reducing the number of charts from now on to reduce page load time!). Increasing the equity content to 80% increases the SWR to 3.86% while shifting to 100% brings the SWR down to 3.74%.
Is Bill still correct?
An (even) more diversified approach
Let's further diversify our portfolio. It still contains 60% equities and 40% bonds but is now broken down as follows:
36% developed market equity
12% developed market small-cap value
12% emerging market equity
40% global bonds
Our SWR for this portfolio is 4.18%. Increasing the equity content to 80% increases the SWR to 4.2%, while the 100% portfolio reduces the SWR slightly to 4.1%. (For those wondering, a 50% equity portfolio has a SWR of 3.9%, not significantly less than the 100% equity portfolio).
A longer retirement
What if we increase our retirement horizon from 30 to 40 years?
Our SWR reduces from 4.18% in the example above to 3.86% (a drop of less than 10% - maybe living too long isn't such an issue for retirement plan sustainability, especially if we consider the chance of living an extra ten years!). Increasing the equity content to 100% now raises the SWR to 3.91%!
Stop focusing on the worst-case outcomes!
So far, we've just been looking at worst-case outcomes. What if we look at the average outcome?
The median case for our 60% equity portfolio has a balance of £2.5m (in real terms) after 30 years.
Our 100% equity example has approximately doubled this, at around £5m - a big difference!
We are (not) the robots!
Unlike Kraftwerk's 1978 classic, humans are not robots, and we all come with our quirks and imperfections. Investors have many biases, some contributing to the investment versus investor behaviour gap (we covered the behaviour gap in our 4% "rule" series).
Guests on a recent Rational Reminder podcast discussed retirees holding 100% equity portfolios. Retirement researcher David Blanchett suggested that "no person that works with real humans would suggest that!"
Vanguard produced a report showing annual returns over the last 120 years, and the worst year
for their 100% equity portfolio at -41% is around 10% worse than the 60% equity portfolio (-31%).
This additional 10% fall may cause the investor to capitulate and sell their investments.
If a retiree had a financial adviser, maybe the adviser could prevent the client from doing this, or perhaps they wouldn't.
The Vanguard chart highlights another important point - the extra return you receive for each additional unit of risk reduces as the portfolio equity content increases. For example, increase the portfolio equity content from 50% to 60% equities; the additional average return is 0.4%.
Increase from 90% to 100% equities; the additional return is only 0.2%. Legendary investor and internet pugilist Cliff Asness recently examined this.
As the Timeline chart below shows, equity drawdowns can be extended (much longer than the one-year periods in the Vanguard example above) and painful, and we realistically haven't had a severe drawdown for around 15 years (the Global financial crisis is #10). Investors tend to have short memories!
We recently wrote about the difficulty of sticking to the plan when portfolios go sideways for a few years. Let's look at the troublesome 2000-2010 period, where investors had to deal with the bursting of the .com bubble and the aftermath of the Global Financial Crisis (GFC).
We will first analyse the whole decade, and to do this, we will use portfolios from the (even) more diversified approach above.
36%Â developed market equity
12%Â developed market small-cap value
12%Â emerging market equity
40%Â global bonds
We can see a reasonable difference in cumulative return (89% versus 70%) over the decade, but the benefits of adding bonds aren't overwhelming, and both examples generated reasonable returns over the decade.
Note that if we use portfolios that are less diversified, adding bonds to a 100% equity portfolio makes a much bigger difference (in relative terms) to the outcome - the annualised cumulative return for the portfolio containing 60% equities being almost four times higher (3.8 versus 1.08) when compared to the 100% equity portfolio. The 100% equity portfolio in this example effectively went nowhere for the whole decade! And that's not forgetting these numbers don't cater for clients drawing down on their retirement pot and potential adviser fees.
Would 100% of investors remain fully invested during this period?
Sticking with the (even) more diversified portfolios, let's now look at the two particularly tricky periods during the decade, starting with the aftermath of the .com bubble. We will cover the period 01/01/2000 to 31/12/2003.
The difference in outcomes is dramatic, with the 100% equity portfolio having a drawdown around three times greater than the portfolio with 40% bonds.
Now, let's look at the GFC, using the period 01/06/2007 to 31/12/2009. Again, we see peak-to-trough drawdowns that are almost twice as bad for the 100% equity portfolio versus the portfolio containing 40% bonds.
Of course, bonds don't always ride to the rescue, but both bands and equities falling significantly together are rarer than people might think. 2022 is often quoted as an example, but with global equities down around 8% over the year (far less than the .com and GFC falls shown above), bonds falling around 12% meant that a 60/40 portfolio was down less than 10% over the year - some would class that as noise. The (even) more diversified portfolio was down by less than 6% which shows the benefits of diversification.
Conclusion
There is a lot to take away from this. Let's first summarise our findings on both a portfolio and personal level.
Portfolio:
Over a 30-year horizon, a 100% equity portfolio doesn't necessarily lead to a higher sustainable withdrawal rate versus a portfolio containing 60% equity and 40% bonds and is often worse.
But it does tend to lead to a better median outcome.
Increase the retirement horizon from 30 to 40 years, and the 100% equity portfolio now has a slightly higher sustainable withdrawal versus the 60% equity portfolio in our analysis.
As equity content increases, the additional additional return tends to reduce as the equity content in the portfolio approaches 100%.
Personal:
A 100% equity portfolio can lead to a greater chance of a "lost decade", especially when fees and retirement withdrawals are considered. Some investors may struggle with this and sell down their portfolios.
Most investors have a breaking point in terms of how far their portfolio falls before they capitulate. The additional drawdowns that a 100% portfolio tends to experience versus a 60% equity portfolio (see our .com bust and GFC examples above) may again cause the investor to capitulate.
Based on the above, when might a 100% equity portfolio in retirement make sense?
If all of the below apply:
Your retirement pot is very large versus your planned withdrawals, meaning there is very little chance of running out of money - your planned withdrawal rate is much lower than the historical SWR, and you don't necessarily need to worry about your retirement funds running out in a worst-case outcome.
Maximising your legacy is a big objective for you, and you care more about improving median/best-case outcomes and maximising the retirement pot at your death. It's worth pointing out that the investment horizon, in this case, effectively becomes much longer than your lifespan (assuming your descendants plan to remain invested)
You are very comfortable with large portfolio drawdowns, and an increased risk of the portfolio balance going nowhere for extended periods of time....
then we could understand a 100% equity portfolio being a consideration.
But we believe this is a small percentage of retirees. For the majority, their situation tends to mean that a portfolio containing bonds is more likely to lead to a better retirement outcome.
Want to find out more?
If you want to find out more about building a robust portfolio that gives you the best chance of retirement success, please get in touch.
About us
The team at Pyrford Financial Planning are highly qualified Independent Financial Advisers based in Weybridge, Surrey. We specialise in retirement planning and provide financial advice on pensions, investments, and inheritance tax.
Our office telephone number is 01932 645150.
Our office address is No 5, The Heights, Weybridge KT13 0NY.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.