Risks and Rewards of International Investing for Retirement Savers Historical Evidence

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Risks and Rewards of International Investing for
Retirement SaversHistorical Evidence

• Gary Burtless
• The Brookings Institution
• Washington, DC USA
• August 2006
• RRC Conference, Washington, DC

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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

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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
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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

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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

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Results100 Allocation to U.S. assets
(1872-2005 returns)
All stocks
All bonds
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ResultsVanguard life-cycle portfolio (based on
1927-2005 returns)
100 US stocks
Vanguard life-cycle
100 US bonds
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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
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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
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ResultsConservative and aggressive efficient
portfolios
Aggressive intl portfolio ___ 100 US stocks
___ Conservative intl portfolio ____
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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