The Limitations of Mean Variance Optimization

In this episode, we welcome back the esteemed Professor Scott Cederburg, Associate Professor of Finance at the University of Arizona. In this highly anticipated episode, Professor Cederburg revisits the show to delve into his groundbreaking paper on life cycle asset allocation. Professor Cederburg's latest research presents findings that disrupt traditional thinking in the field, prompting a deep dive into the implications of these new insights. In our conversation, we unpack the findings from the paper and how they challenge established norms in retirement planning and asset allocation. We discuss what the new paper adds to the discourse, his approach and methodology, the different assessment criteria used, and the main findings from the paper. We also delve into the different asset allocation strategies assessed, which strategy performed best, aspects that would influence the various strategies, and how to invest for the long term safely. We explore the nuances of stock versus bond returns and the hidden benefits of international diversification. Gain profound insights into the significance of social security, inflation-protected bonds, target date funds, and the repercussions of an all-equity strategy. Comparing his latest paper with prior research on withdrawal rates, Professor Cederburg highlights surprising aspects of the results and provides invaluable takeaways for financial advisors from these cutting-edge findings. Discover how this pioneering work challenges conventional wisdom, reshaping the landscape of retirement planning and investment strategies in this illuminating conversation with Professor Scott Cederburg.

Key Points From This Episode:

• Background about Professor Cederburg and episode overview. (0:00:00)

• How his new paper challenges the central tenets in life cycle investing. (0:03:38)

• What sets his method apart regarding its ability to challenge the status quo. (0:06:56)

• How he characterizes the life cycle of the household modelled in his study. (0:09:40)

• The data set used and his approach for sampling and analyzing the data. (0:12:09)

• Retirement outcomes used to evaluate life cycle asset allocation strategies. (0:13:56)

• Asset allocation strategies investigated in the paper and which one performs best. (0:15:49)

• Left tail outcomes of all-stocks strategy, stock returns vs bond returns, and the benefits of international diversification. (0:22:52)

• Learn about the importance of social security in the model and the nuances of inflation-protected bonds. (0:28:29)

• Investing in target date funds and the downsides of an all-equity strategy. (0:32:05)

• Hear about the impact of large intermediate losses on retirement savings. (0:35:33)

• Unpacking the lag time on returns between stocks and bonds. (0:40:01)

• Exploring investing behaviour and reasons for underperformance. (0:42:15)

• The importance of return dependencies and what happens to the results if monthly returns are used. (0:45:03)

• Navigating and modelling flaws and common aspects overlooked in financial analyses. (0:49:29)

• Dissecting retiree adherence to traditional approaches to long-term investing. (0:50:36)

• Home country bias and its influence on portfolio allocation. (0:52:12)

• Currency effect and domestic stock hedging as a strategy. (0:55:32)

• Comparing the findings from his latest paper with those from his paper on withdrawal rates. (1:00:24)

• Aspects of the results that surprised him and takeaways for financial advisors from the latest research findings. (1:02:07)

Links From Today’s Episode:

Professor Scott Cederburg — https://eller.arizona.edu/people/scott-cederburg

Professor Scott Cederburg on LinkedIn — https://www.linkedin.com/in/scott-cederburg/

Professor Scott Cederburg on Google Scholar — https://scholar.google.com/citations/

Eller College of Management — https://eller.arizona.edu/

Episode 224 — https://rationalreminder.ca/podcast/224

Episode 250 — https://rationalreminder.ca/podcast/250

‘Beyond the Status Quo: A Critical Assessment of Lifecycle Investment Advice’ — https://dx.doi.org/10.2139/ssrn.4590406

‘The Safe Withdrawal Rate: Evidence from a Broad Sample of Developed Markets’ — https://dx.doi.org/10.2139/ssrn.4227132

International Diversification Works (Eventually) — https://doi.org/10.2469/faj.v67.n3.1

‘Stocks for the long run? Evidence from a broad sample of developed markets’ — https://www.sciencedirect.com/science/article/

Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582. Rational Reminder Website — https://rationalreminder.ca/ 

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Rational Reminder Email — info@rationalreminder.caBenjamin Felix — https://www.pwlcapital.com/author/benjamin-felix/ 

Benjamin on X — https://twitter.com/benjaminwfelix

Benjamin on LinkedIn — https://www.linkedin.com/in/benjaminwfelix/

Cameron Passmore — https://www.pwlcapital.com/profile/cameron-passmore/

Cameron on X — https://twitter.com/CameronPassmore

Cameron on LinkedIn — https://www.linkedin.com/in/cameronpassmore/