Go Global to Boost Retirement Assets
Reprinted courtesy of MarketWatch.com.
To read the original article click here.
By the time most of us start thinking seriously about retirement, we are likely to be attracted to comfort and familiarity more than to adventure. However, retirees who keep their investments too close to home can wind up paying a high price for comfort.
For decades, I have preached the merits of investing in funds that own stocks of companies outside the U.S. I once described this as “putting the whole world to work for you” — and it’s a terrific idea. Let me show you why.
The equity part of every portfolio I recommend is split evenly between U.S. stock funds and international stock funds. Some advisers and managers think this is much too much emphasis on international, but the long-term payoff has never failed to show up.
Less than half the world’s stock market value resides in companies based in the United States. Retired investors should pay special attention to this.
Of course, international companies don’t always outperform domestic ones. That was certainly true in the 1990s, when a great bull market in U.S. stocks convinced many investors that all they needed was right here.
But the bear markets that followed in the early years of this century demonstrated that diversification, including the ownership of international stocks, can be a blessing. In the past decade, emerging markets stocks (one part of my recommended international mix) have turned in great returns.
We have reliable data going back to the 1950s for international stock indexes, and it’s instructive to look at some numbers.
In my book “Live It Up Without Outliving Your Money,” I described a 38-year study comparing two well-diversified all-equity portfolios. One was made up entirely of U.S. stock indexes, the other split 50/50 between U.S. and international indexes.
Over this long period, the all-U.S. portfolio’s return was 12.1%; the half-and-half portfolio’s performance was 13.7%. In any single year, that’s not a life-changing difference. But over a few decades, that can be the difference between retiring comfortably and barely scraping by. Think this is a risky strategy? In nearly every way we measured, we found the internationally diversified portfolio was less risky.
This is exactly the combination that retirees need: higher returns with less risk. And it’s easily available using index funds.
It’s true that in the past three years U.S. stocks have outperformed international ones. However, over the past 10 years, according to Morningstar data, a two-fund portfolio composed of equal parts of U.S. large companies and U.S. small-cap companies returned 8.8%; a four-fund combination of large and small companies, both U.S. and international, returned 9.75%.
And remember, this happened during a 10-year period that was extremely unnerving for millions of investors.
Now here’s where retirees should pay special attention: If you are withdrawing money from your portfolio, international diversification is much more valuable than it looks at first glance. Even when they don’t boost returns, international stocks can help keep a retirement portfolio healthy.
As I wrote in “Live It Up Without Outliving Your Money,” a portfolio that must support regularly increasing withdrawals (to keep abreast of inflation, for example) has very different needs from a portfolio that’s accumulating money for some future retirement. To keep a retirement portfolio alive for many years, stability, or the lack of big losses, is critical. Even a single really bad year can ruin things.
The biggest financial risk that most retirees face is running out of money prematurely. In my book I presented a 38-year study showing what would have happened to three portfolios, based on actual returns starting in 1970.
Each hypothetical portfolio began with $1 million and was tasked with providing its owner with $60,000 in the first year and increasing yearly withdrawals in every subsequent year to keep up with actual inflation.
One-half of each portfolio was invested in fixed-income funds. The differences I’m about to describe are only the result of how the 50% equity part was invested.
The first portfolio contained only U.S. stocks in the equity portion. By the end of 2007, the full portfolio was worth $500,226. At the start of 2008, even without the market’s upcoming hideous plunge, this portfolio was doomed, as it had to provide its owner with about $214,000 for living expenses.
The second portfolio was identical to the first except for one change: 30% of the equity portion, or 15% of the entire portfolio, was allocated to international stocks instead of U.S. stocks. The 50% in fixed-income remained unchanged, and the majority of the equity portion was unchanged.
However, this shift, which affected only 15% of the portfolio, had a dramatic effect. At the end of 2007, this portfolio was worth about $4.2 million, making it worth eight times as much as the first one, which lacked any international stock exposure.
The third portfolio had 25% in international stocks instead of 15%. At the end of 2007, the portfolio was worth more than $6.5 million.
I think the lesson for retirees is simple and clear: If you want to “live it up without outliving your money,” you should include international stocks in your portfolio.
Richard Buck contributed to this article.