The biggest question facing a retiree who wants to live partly off of an investment portfolio is this: Will the portfolio sustain my withdrawal rate, and keep up with inflation, throughout my retirement? Retirees don’t want to run out of money before they die. But they also want a reasonable income that isn’t devastated by inflation.
Much has been written about what is a reasonable, sustainable withdrawal rate. A sustainable withdrawal rate is one that will give the retiree a good chance of maintaining an adequate income over a lengthy retirement. The general wisdom is that a withdrawal rate of 5% or less—in some researchers’ opinions, no more than 4%—will withstand just about anything the markets can throw at a portfolio. Even then there is disagreement over whether a portfolio of stocks and bonds will survive a lengthy retirement, even at a 4% withdrawal level.
How can a retiree hedge his bets and improve his chances of success? Retirement investors can improve their chances of success by putting part of their portfolios into international stocks and bonds. A recent study for the Journal of Indexes that used newly available long-term data for foreign markets found that a 30% allocation to foreign stocks and bonds dramatically improved the sustainability rates of portfolios with varying risk levels. The study used a new database of international bond and stock returns from 1900 through 2003. It constructed six different portfolios, ranging from 100% stock to 100% bond. Each portfolio had 30% of its assets in foreign stocks and bonds.
The results were striking. Over 30-year withdrawal periods, using an annual withdrawal of 4%, four out of five portfolios did better with foreign securities. The same result held true for a 5% withdrawal rate over 30 years. For instance, a portfolio with 40% of its assets in stocks and 60% in bonds, and that was partly invested in international stocks and bonds, had a 100% success rate using a 4% annual withdrawal, meaning that in every 30-year period the retiree did not run out of money, no matter what the markets did. The U.S.-only portfolio succeeded only 90% of the time. Over 40-year withdrawal periods the globally diversified portfolios beat U.S.-only portfolios at every risk level for both 4% and 5% withdrawal rates.
Why is this so? The open secret is that international stocks and bonds don’t move in lockstep with domestic stocks and bonds. Also, their volatility levels are different than the volatility levels of domestic securities. Some analysts have argued that as commerce becomes more globalized, international investments will become more correlated with domestic investments. The Journal’s study found that still has not happened. In fact, the correlations between foreign markets and the U.S. market have been higher during past periods than they are today. Although the long-term trend appears to be toward closer correlation of international and domestic returns, the study found that the correlations were higher in the 1920s, the 1930s, and the 1950s than they were in the 1980s and 1990s. “This points out that—contrary to popular opinion—recent correlations between U.S. and international assets are actually lower (and not higher) than some past correlations,” it said.
