June 25th, 2019 | by

The Retirement Investment Challenge

  • Investor confidence, more than attractively valued securities, appears to be supporting stock prices.
  • Investors need to take far more risk than 15 or 30 years ago to earn the same expected return.
  • Investors might consider increasing retirement savings, rather than taking excessive investment risk, to meet retirement-funding needs.

On June 20, major US stock indices, including the S&P 500 Index, charged to record highs. Since March 2009, US stock prices have more than quadrupled. How much longer will the good times roll on? I make no predictions, but I would observe that it is investor confidence–and not asset values–that seems to be propelling security prices.

Confidence can change on a dime. Certainly, there is no shortage of risks out there, from financial (e.g., the rapid accumulation of public- and private-sector debt in the US and around the globe) to geopolitical (e.g., Brexit, and tensions between the US and both Iran and China). Instead of weighing potential risks, bullish investors are choosing to focus on the dovish shift in US Federal Reserve monetary policy, including the Fed’s recent intimations of interest-rate cuts ahead, and the loose monetary policy (a form of “artificial support”) adopted by other central banks from Japan to Europe. Unfortunately, due to behavioral bias, investors are prone to extrapolate recent trends (e.g., rising asset prices and low volatility) into the future, whereas recent events contain little or no information about what is to come.

Something that concerns me is that investors, intoxicated by gains in both stocks and bonds during the past decade, are not appropriately discounting risk as they save and invest for retirement. To illustrate the current challenge for retirement savers, I conducted some research, drawing on data from Callan Associates.

Regime Change

Let’s say you’re nearing retirement (or are in retirement) and seek to earn a 7.5% annualized portfolio return. Exhibit 1, which takes into account asset-class valuations (including interest rates for fixed income), illustrates how dramatically the investment landscape has shifted over the past 30 years. In 1989, when a high interest-rate regime prevailed, an investor could target a 7.5% expected return (for an investment horizon of 15 years) simply by allocating all funds to a very low-risk cash and fixed-income portfolio. Note that the risk (i.e., volatility as measured by standard deviation) for such a portfolio is only 3%.

Fifteen years later, in 2004, to achieve the same 7.5% return, an investor would need to allocate half of the portfolio to stocks and accept three times as much volatility. Today, when interest rates are exceptionally low by historical standards, I estimate that an investor would need to keep 96% of the portfolio in stocks and other “risky” assets to target a 7.5% return. Such a portfolio would incur twice the volatility of the 2004 one and six times as much as the low-risk 1989 portfolio.

Taking on more risk in pursuit of higher returns may not be an appropriate strategy for many investors. One alternative, given what the markets (i.e., relatively high stock and bond prices) are offering us today, is to reduce return expectations and portfolio risk while boosting savings and investment. Indeed, when I conducted a “Q Factor” podcast a while back with Robert Merton, the Nobel laureate discussed how many Americans, due to longevity and excessively optimistic portfolio-return expectations, will face a retirement-funding crisis. One simple solution for workers: boost savings and investment. To hear more retirement-investment advice from Merton, I invite you to listen to our podcast:



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