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Risks and Rewards of International Investing for Retirement Savers Historical Evidence

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Conversion of savings to level annuity at retirement (age 62) ... Long government bond rate determines ... 100% US stocks. 100% US bonds. Results: The good news ... – PowerPoint PPT presentation

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Title: Risks and Rewards of International Investing for Retirement Savers Historical Evidence


1
Risks and Rewards of International Investing for
Retirement SaversHistorical Evidence
  • Gary Burtless
  • The Brookings Institution
  • Washington, DC USA
  • August 2006
  • RRC Conference, Washington, DC

2
Can retirement savers benefit from cross-national
diversification?
  • Defined-contribution pension contributors
  • Worker control over investment portfolio
  • Conversion of savings to level annuity at
    retirement (age 62)
  • Pension replacement rates at retirement
  • Alternative portfolios
  • With and without overseas investments

3
Source of concern Excess sensitivity of
pension to late-career returns
Geometric mean return over career 7. In
exactly one year during career Return
-50. In other 39 years Return 9.1.
114
9
53
5.6
4
Source of concern Persistence of bad returns
although not in these 3 countries
Stock returns
5
Source of concern Persistence of bad returns
Stock returns
6
Source of concern Persistence of bad returns
big time
-2.9
-10.2
Japan Stock returns
7
Another source of concern High variability of
overseas returns
8
International investingPortfolio allocation /
country weights
  • In target-retirement-year funds
  • Vanguard
  • T. Rowe Price
  • Fidelity
  • In proportion to countries market weights
  • In proportion to countries GDP weights
  • 1980 2005
  • Optimal portfolio on the efficient frontier

9
Assumptions
  • 40-year career
  • Predetermined portfolio allocation
  • Fixed asset allocation
  • Life-cycle asset allocation
  • Take account of fund management costs
  • Conversion to single-life annuity at age 62
  • Long government bond rate determines annuity
    price
  • Workers goal Highest possible replacement rate

10
Results100 Allocation to U.S. assets
(1872-2005 returns)
All stocks
All bonds
11
ResultsVanguard life-cycle portfolio (based on
1927-2005 returns)
100 US stocks
Vanguard life-cycle
100 US bonds
12
Results The good newsVary percent of equities
allocated to foreign stock
100 foreign stocks
50 for. / 50 US
100 US stocks
Pension results in good years
13
Results The bad newsVary percent of equities
allocated to foreign stock
50 for. / 50 US
100 US stocks
100 foreign stocks
Pension results in bad years
14
ResultsConservative and aggressive efficient
portfolios
Aggressive intl portfolio ___ 100 US stocks
___ Conservative intl portfolio ____
15
Conclusions
  • In theory International should help
  • Compared to 100 US stock portfolio
  • Life-cycle fund reduces average pensions
  • Increases risk of low pensions
  • Result due to high allocation to bonds
  • Naïve international diversification
  • Improves average and best pensions
  • Increases risk of very low pensions
  • Efficient international portfolios can
  • Increase median and top-end pensions
  • Without harming pensions in worst years
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