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Bonds riskier than stocks long term
The simulation
The researchers simulated a million hypothetical lifetimes by stitching together blocks of about ten years of returns drawn from the data. A domestic block meant a country's own returns in its own currency, and an international block meant the combined returns of all the other countries in that currency. The method is called bootstrap simulation.
What performed best
They tested target date funds, which shift toward bonds over time, a mix of 60% stocks and 40% bonds, and domestic-only stock portfolios. Each was scored on the satisfaction of retirement spending, the money left at death, and the probability of running out. The best performer was an all-stock portfolio with about a third in the home country and two thirds international. For a US investor, the curve was fairly flat between 10% and 50% domestic.
Inflation and bonds
High inflation hurts retirement spending and domestic stock returns, and international stocks protect against it. Bonds, which are loans to a government repaid with interest and the principal at the end, get absolutely decimated in periods of high inflation. The idea that portfolios should move toward bonds with age is so ingrained that the paper drew heavy controversy from professionals and other academics.
Why do bonds suffer when inflation spikes?
A bond pays fixed interest, so rising prices shrink what those payments can buy. New bonds then offer higher yields, which pushes down the price of older ones. In 2022, as US inflation reached a 40-year high, the Bloomberg US Aggregate Bond Index fell about 13 percent, its worst calendar year on record.
Why do target date funds shift toward bonds?
The logic starts from the idea that a young worker's future paychecks act like a steady, bond-like asset, so savings can lean toward stocks early on. As retirement nears, a market drop leaves less time to recover. Target date funds built this into a glide path, a schedule that shifts from stocks to bonds as the target year approaches. The first such funds launched in the early 1990s.
Why do investors keep most money at home?
The habit is called home bias. In a 1991 paper, Kenneth French and James Poterba reported that US investors held about 94 percent of their equity in US stocks, when US shares made up under half of the world market. Later studies found home bias has declined over time but remains large in many countries.
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