The Rational Reminder Podcast

Episode 284: Prof. Scott Cederburg: Challenging the Status Quo on Lifecycle Asset Allocation

Dec 21, 2023

01:09:28

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Prof. Scott Cederburg challenges traditional life cycle asset allocation in retirement planning. He discusses modeling returns, optimal allocation between domestic and international stocks, safe withdrawal rates, and the perception of volatility in investments.

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Quick takeaways

All-equity strategies, particularly a 50-50 mix of domestic and international stocks, tend to outperform age-based stock-bond approaches like target-date funds in terms of higher wealth at retirement, generally safer retirement income, and lower ruin probabilities during retirement.

Short-term correlations between asset classes can be misleading, and returns over longer horizons may exhibit mean reversion and other important properties, suggesting that all-equity strategies, despite their higher short-term volatility, can be safer and more beneficial for long-term investors.

A 100% equity strategy remains optimal for retirement portfolios, even when considering factors like Social Security. Diversifying with bonds or target-date funds does not yield better outcomes in terms of wealth accumulation and retirement consumption, challenging conventional wisdom about the safety of bonds.

Deep dives

Challenging Traditional Life Cycle Investing Advice

In this podcast episode, Professor Scott Cedarberg challenges two common pieces of investment advice related to life cycle investing. The first is the recommendation to diversify across stocks and bonds, which is often implemented through popular rules of thumb like the 60/40 portfolio. The second is the notion that younger individuals should invest more heavily in stocks compared to older individuals. Professor Cedarberg's research challenges these ideas by analyzing real returns over long periods of time and considering factors such as inflation and currency fluctuations. He finds that all-equity strategies, particularly a 50-50 mix of domestic and international stocks, tend to outperform age-based stock-bond approaches like target-date funds. These all-equity strategies lead to higher wealth at retirement, generally safer retirement income, and lower ruin probabilities during retirement. The results suggest that a traditional emphasis on bonds for capital preservation may not be as beneficial as previously thought.

Prepare for Stock Market Volatility in Diversified Portfolios

00:32

Maintaining Commitment to Investment Strategy During Market Volatility

00:36

Optimizing Strategy through Data Analysis

00:26

Introduction

3min

Challenging Traditional Life Cycle Asset Allocation

23min

The Limitations of Mean Variance Optimization

21min

Analysis of Return Modeling Approaches

6min

Optimal Allocation Between Domestic and International Stocks

9min

Safe Withdrawal Rates and the Role of Domestic and International Stocks

8min

Exploring Volatility and Perception in Investments

2min

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)