Foreign stocks/bonds may be less beneficial for retirees

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Browser
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Foreign stocks/bonds may be less beneficial for retirees

Post by Browser »

Read a thought-provoking commentary recently which argues that international diversification may be detrimental for retirees who are taking income withdrawals from their investment portfolios. Diversifying internationally may be more beneficial for investors who are accumulating, for the same reasons it may be detrimental for retirees. The reasons given are the following:

1) Adding foreign stocks increases the volatility of portfolio returns. Volatility is not the friend of investors who are withdrawing money because it exacerbates sequence-of-return risk. However, volatility may be more beneficial for accumulators because it can enhance the benefit of dollar cost averaging and sequence of return risk is not as important for them.

2) Adding foreign stocks adds the additional layer of currency risk. U.S. retirees, who are spending their money in USD, are better off not adding currency risk to their portfolios by investing in foreign securities. Accumulators may benefit from fluctuations in currency exchange rates because this might increase diversification benefits.

Food for thought.
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by z3r0c00l »

Currency risk = currency diversification. International isn't beneficial if domestic does better. If domestic tanks a year before retirement, suddenly international may be helpful. If you are not disappointed by at least one investment at any given time, diversification is not working.

I can't imagine this argument being true; one counts on a domestic economy for a job, housing, retirement, public services, and then intends to put all of his money in domestic too?
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by magneto »

Yes : Two good points ; difficult to argue against.
However we often point out the sorry history of the investor in Japan, had they been 100% domestic stocks from 1989.
Maybe the two points are good reasons to keep international lower than market caps by tilting to domestic in retirement, rather than making a simple yes/no decision on international ?
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by lack_ey »

Oh yes, for sure. A third big argument is that a US investor's human capital is tied to the US during working years.

I plan on a slowly decreasing glidepath of international equity (say 50% or so to maybe 25% in retirement), though I see this strategy mentioned virtually nowhere. International diversification matters more early on and has greater risks in retirement. I wouldn't think the drawbacks suggest 0% is most appropriate in retirement, but certainly there are reasons to go lower if one wants to depart from global market cap weighting.
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by House Blend »

Browser wrote:1) Adding foreign stocks increases the volatility of portfolio returns.
Yes, portfolio volatility is more important for retirees, but I'd like to see evidence in support of that statement. Adding small amounts of stock to a bond-only portfolio typically reduces volatility.

In any case, a portfolio with only US stocks is less diversified than one that has US + Intl, and diversification remains one of the main tools we have for damping portfolio volatility.

This looks more to me like a search for excuses to dump international.
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by baw703916 »

But isn't currency risk the reason for the greater volatility of foreign stocks? Maybe not for Emerging Markets, but for IDM I don't see any reason for greater volatility apart from currency risk. So points 1 and 2 are really different ways of saying the same thing.

Does the addition of international always increase volatility of the overall portfolio, even in relatively small amounts? It's hard to see where this must always be the case, especially in the unknown future. It's a complicated dependency on the relative returns, volatilities, and correlations of the two asset classes during your retirement years. Good luck trying to predict that.

I don't see where having international as 20-30% of equities is going to make ones portfolio dramatically more volatile, and there might be a diversification benefit.
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by lack_ey »

House Blend wrote:
Browser wrote:1) Adding foreign stocks increases the volatility of portfolio returns.
Yes, portfolio volatility is more important for retirees, but I'd like to see evidence in support of that statement. Adding small amounts of stock to a bond-only portfolio typically reduces volatility.

In any case, a portfolio with only US stocks is less diversified than one that has US + Intl, and diversification remains the main tool we have for damping portfolio volatility.

This looks more to me like a search for excuses to dump international.
Depends on the time scale and assumptions, but with current correlations and volatility, even with equal assumed returns international should be off the efficient frontier because of increased standard deviation.

Adding small amounts of stock to a bond-only portfolio can reduce volatility because the correlations there are close to 0. When you're working with correlations more in the 0.8-0.9 range, it's a lot different.

I admit to not having run the numbers myself to check, but here's a similar style of analysis for US size/value styles (the important factor here being the high correlations, higher volatility):
viewtopic.php?f=10&t=156592

There are things to be said for (against) a purely MPT-based analysis on say monthly or yearly returns, though.

baw703916 wrote:But isn't currency risk the reason for the greater volatility of foreign stocks? Maybe not for Emerging Markets, but for IDM I don't see any reason for greater volatility apart from currency risk. So points 1 and 2 are really different ways of saying the same thing.
Currency risk is the primary factor, but the data shows greater volatility in other markets in their currency (i.e. without any foreign exchange effect), even developed markets, though because of imperfect correlations the volatility is lowered if you take the blend of countries. I forget where I've seen this data, sorry. I'm thinking it might have been a Vanguard white paper.
baw703916 wrote:I don't see where having international as 20-30% of equities is going to make ones portfolio dramatically more volatile, and there might be a diversification benefit.
I don't either. But there might not be much diversification benefit either, especially in the short term—say for early stage retirement withdrawals—and a market crash.
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by House Blend »

lack_ey wrote:
House Blend wrote:
Browser wrote:1) Adding foreign stocks increases the volatility of portfolio returns.
Yes, portfolio volatility is more important for retirees, but I'd like to see evidence in support of that statement. Adding small amounts of stock to a bond-only portfolio typically reduces volatility.

In any case, a portfolio with only US stocks is less diversified than one that has US + Intl, and diversification remains the main tool we have for damping portfolio volatility.

This looks more to me like a search for excuses to dump international.
Depends on the time scale and assumptions, but with current correlations and volatility, even with equal assumed returns international should be off the efficient frontier because of increased standard deviation.
The Vanguard white paper on this topic comes to the opposite conclusion.

In fact, the title of Figure 3 (p. 5) is "Adding non-U.S. stocks has historically reduced the total volatility of a portfolio." The weasel words in the footnotes include:
Notes: U.S. equities represented by MSCI USA Index; non-U.S. equities represented by MSCI World Index ex USA from 1970 through 1987 and MSCI All Country World
Index ex USA thereafter. Bond data represented by the Salomon High Grade Index from 1970 through 1972, the Lehman Long-Term AA Corporate Index from 1973 through
1975, and the Barclays Capital U.S. Aggregate Bond Index thereafter. Data through December 31, 2010.
URL: https://personal.vanguard.com/pdf/icriecr.pdf
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by nisiprius »

Browser wrote:... 1) Adding foreign stocks increases the volatility of portfolio returns. Volatility is not the friend of investors who are withdrawing money because it exacerbates sequence-of-return risk. However, volatility may be more beneficial for accumulators because it can enhance the benefit of dollar cost averaging and sequence of return risk is not as important for them.
Look, I'm a foreign-stock skeptic, but let's look at magnitude and not just direction.

If you take a U.S. stock index fund, and a broadly diversified international fund that is primarily invested in developed markets--like Vanguard Total International--in the past data that hasn't increased volatility by a lot. Maybe it didn't decrease it. Maybe it did, but again, not by a lot.

Vanguard Total World is a fair example of "adding" international to U.S., it's about 50/50. On their 1-5 rough risk categorization, Vanguard puts Total [U.S.] Stock at 4; Total International at 5 (i.e. they say it is more risky); but Total World at 4. Vanguard says that 100% U.S. and 50/50 U.S./international have about the same volatility.

For whatever they're worth--Total World only goes back five years--Morningstar is showing the 5-year standard deviations as:

Vanguard Total [U.S.] Stock Market Index Fund (VTSMX), 13.63
Vanguard Total International Stock Market Index Fund (VGTSX), 16.96
Vanguard Total World Stock Market Index Fund (VTWSX), 14.88.

On the face of it, did adding international reduce volatility? No, it did not, not over the last five years anyway. Did it increase it by enough to care about? Not in my opinion. In 2008-2009, from inception of Total World to the bottom, it fell 48.9% while Total Stock fell "only" 47.9%. That's not the difference between jumping out of the window and staying in.

Image

By taking on international, you are taking on a little more risk. But not a lot.
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by lack_ey »

House Blend wrote:[...]
The Vanguard white paper on this topic comes to the opposite conclusion.

In fact, the title of Figure 3 (p. 5) is "Adding non-U.S. stocks has historically reduced the total volatility of a portfolio." The weasel words in the footnotes include:
Notes: U.S. equities represented by MSCI USA Index; non-U.S. equities represented by MSCI World Index ex USA from 1970 through 1987 and MSCI All Country World
Index ex USA thereafter. Bond data represented by the Salomon High Grade Index from 1970 through 1972, the Lehman Long-Term AA Corporate Index from 1973 through
1975, and the Barclays Capital U.S. Aggregate Bond Index thereafter. Data through December 31, 2010.
URL: https://personal.vanguard.com/pdf/icriecr.pdf
I said with "current correlations" (maybe last 10-20 years). See Figure 5a in the paper linked. When correlations were lower, there was more of an MPT-based argument to be made. This wasn't the particular paper I was referring to, by the way, though you couldn't have known that. I wish I could remember what it was.

If you want a data set a little longer than 5 years (around 15), see here for 60/40 portfolios (Vanguard balanced index vs. Vanguard lifestrategy moderate growth, with the caveat that I think the latter has been monkeyed around with recently):
https://www.portfoliovisualizer.com/ass ... BIAX+VSMGX

Last 7 years, other funds:
https://www.portfoliovisualizer.com/ass ... BIAX+VSMGX


In any case, nisi's point above about the magnitude of differences is still maybe the most useful one to make.
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by baw703916 »

Nisiprius,

Two comments:

For a longer time period, comparing the EAFE index and the S&P 500 can get you back to 1970. Over that entire time, the annualized return of the two has been very close (within about 10 bp the last time I calculated it), but the standard deviation of the EAFE has been several % higher. That suggests that the extra risk of the EAFE (when denominated in USD) is uncompensated, and this is consistent with it being currency risk (but doesn't prove that that is what it is).

If the future resembles the past, then it isn't likely that including international is going to get you a lot, or cost you a lot by being more risky. But since one of our goals as investors is to be prepared in case the future doesn't resemble the past, I prefer to include international "just in case".
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by Levett »

"I prefer to include international "just in case."

"Just in case" drives a number of my investment decisions.

Frankly, I find "just in case" more compelling than a great deal of mumbo jumbo produced by Vanguard and any number of other investment companies.

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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by Johno »

baw703916 wrote:Nisiprius,

Two comments:

For a longer time period, comparing the EAFE index and the S&P 500 can get you back to 1970. Over that entire time, the annualized return of the two has been very close (within about 10 bp the last time I calculated it), but the standard deviation of the EAFE has been several % higher. That suggests that the extra risk of the EAFE (when denominated in USD) is uncompensated, and this is consistent with it being currency risk (but doesn't prove that that is what it is).

If the future resembles the past, then it isn't likely that including international is going to get you a lot, or cost you a lot by being more risky. But since one of our goals as investors is to be prepared in case the future doesn't resemble the past, I prefer to include international "just in case".
You seem to refer to standalone std dev of risk, Nispirus seemed to be referring to the effect of adding international to a portfolio otherwise all US. EAFE std dev of return could be higher but a significant addition (substitution) of it in a portfolio not increase the portfolio's vol. That seems to be the general result over most periods AFAIK, slight addition/reduction in portfolio vol depending on period and % and foreign benchmark.

I think 'currency risk' tends to be a misleading term when speaking about stock. A lot of people, not saying you do, seem to make the assumption a stock that uses a foreign currency as unit of account acts like a promise to pay a fixed number of units of a foreign currency. Actually the correlation relationship is much weaker. Moreover this is an aspect where there's solid reason to believe the future *won't* be like the past: business is more internationalized now than decades ago. And this is an argument actually used by anti-foreign stock types: 'you can get your foreign exposure via the foreign businesses of US companies'. But if that's true the US stocks must also have 'currency risk', which comes from the underlying business (and capital structure of the firm) not actually from the currency used as unit of account. The 'currency risk' of US stocks might be less, but then again the argument that holding them really diversifies you globally is less...than at all convincing IMO.

The other significant factor now is *diversifying* (note not getting a 'free lunch' but diversifying) between the quite different valuation relative to earnings now given to US stocks v those in most other countries. Maybe that's the market's final decision forever, maybe not. I'd rather diversify and hedge that bet.

So I'm more pro-foreign than 'just in case' but just in case works just as well.

This is always a good discussion but I don't see much of a new or different angle for retirees. The opening statement seems to assume 'accumulators' could benefit from return-free extra risk but retirees couldn't. But standard 'Modern Portfolio Theory' concepts say nobody should want to do that. The simplifications of MPT are sometimes perhaps oversimplifications, but I think it still has to be explained further why either type of investor would want more 'risk' for no more return, if that's really true.
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by stlutz »

It's probably worth looking at volatility and it's impact on "sequence of returns" risk from a wholistic perspective. If your equity allocation is high enough that the currency risk of international stocks matters in any significant way, then the issue is probably too much in equities as opposed to just the currency issue with international stocks.

Another good option for retirees to consider would be VG's Global Minimum Volatility fund which has about 50/50 US vs. International but also hedges the currency exposure.

As a side note, many corporations hedge their currency exposure as well. Just because a company generates a lot of revenue from overseas sales doesn't mean that is has a lot of foreign currency exposure.
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by MossySF »

Well of course foreign stocks would be less beneficial for retirees.

When you're starting out, 50% of your 100% of stock is 50% of your portfolio.

When you're retired, 50% of your 20% stock is 10% of your portfolio. 10% is near the level where you can take it or leave it and not see much difference.
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by grabiner »

Browser wrote:1) Adding foreign stocks increases the volatility of portfolio returns.
The reason to add foreign stocks is that some diversification decreases the risk. While foreign stocks have the additional risks of their own markets and of currency fluctuation, these risks are not correlated with US stock risk. Thus, reducing your US stock allocation slightly reduces the US-specific risk of your portfolio, and adding a small amount of foreign-specific risk does not increase the overall risk of your portfolio much because it is uncorrelated.

Many models estimate that adding 20-30% foreign stock to a US-stock portfolio decreases the risk, assuming that foreign stocks have higher risk than US stocks but that the additional risk is not correlated with US stock risk.
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by randomguy »

magneto wrote:Yes : Two good points ; difficult to argue against.
However we often point out the sorry history of the investor in Japan, had they been 100% domestic stocks from 1989.
Maybe the two points are good reasons to keep international lower than market caps by tilting to domestic in retirement, rather than making a simple yes/no decision on international ?
No need to go to Japan. Look at the sorry history of the 1970's US retiree that was 100% US stock versus his counterpart that was 70/30. When you start sucking money out of an account, the fact that international and US outperform each other at various points begins to matter.
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by Valuethinker »

Browser wrote:Read a thought-provoking commentary recently which argues that international diversification may be detrimental for retirees who are taking income withdrawals from their investment portfolios. Diversifying internationally may be more beneficial for investors who are accumulating, for the same reasons it may be detrimental for retirees. The reasons given are the following:

1) Adding foreign stocks increases the volatility of portfolio returns. Volatility is not the friend of investors who are withdrawing money because it exacerbates sequence-of-return risk. However, volatility may be more beneficial for accumulators because it can enhance the benefit of dollar cost averaging and sequence of return risk is not as important for them.

2) Adding foreign stocks adds the additional layer of currency risk. U.S. retirees, who are spending their money in USD, are better off not adding currency risk to their portfolios by investing in foreign securities. Accumulators may benefit from fluctuations in currency exchange rates because this might increase diversification benefits.

Food for thought.
The argument is true in the sense that if you hold foreign stocks you are taking on currency risk and given you are in a withdrawal phase that means assets not equal to liabilities (in currency). A BAD THING.

However as others point out there is the 'in case' eg Japan.

That suggests 20-30% in foreign equities (ie perhaps 15% of total wealth) is no bad thing. If the fixed income/ DB pension/ annuities bit of the portfolio is in USD, taking on a bit of currency risk in equities is probably no great evil.

There is always the chance that something very specific to the US markets will cause disaster (say the Canadians might invade and impose healthcare, plaid shirts and Molson's Beer; Dan Akroyd becomes president; Michael J Fox as secretary of health; Justin Bieber at the Department of Justice -- just imagine it! Anyone seen Amerika? that was filmed in part in Toronto, so you never know ...; imagine New Yorkers being forced to say 'thank you very much' even to their ATMs, and volume limits being imposed on people speaking in public places...; Rob Ford as Transport Secretary .. the horror! the horror! )*.

* Tim Hortons outlets could be the first phase of this insidious northern plan. They are spreading, and certainly the coffee and donut combination has strange mental effects ....
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by BlueEars »

nisiprius wrote:...(snip)...
On the face of it, did adding international reduce volatility? No, it did not, not over the last five years anyway. Did it increase it by enough to care about? Not in my opinion. In 2008-2009, from inception of Total World to the bottom, it fell 48.9% while Total Stock fell "only" 47.9%. That's not the difference between jumping out of the window and staying in.
...
I like this point of view as it shows a period where the US was outperforming the International.

I don't have time to produce a graph of a 50/50 US/International versus a pure US (but it would be pretty easy to do with Yahoo monthly data). Here is an M* view going back to 1996 for US and International (as Nsiprius says the world fund is not old enough yet):

Image

Looking at just the orange US and the blue International, we might say "mind the gap". Since 2007 or so the US has outperformed and hence a lot of posts asking "why international?" or noting extra volatility. The 2002 to 2007 period was, of course, the opposite (gap closing, international outperforming).

As a last thought, I'm retired but I do like to occasionally take international trips which means lots of Euro or Pound purchases. As a percentage of our spending that still is pretty low, maybe less then 15%. Then there are indirect world goods purchases and who knows how the "gaps" work there.
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by Browser »

It's a tale of two cities when it comes to international diversification, marked by the rise and fall of Japan, Inc. There are two very different stories: 1972-1989 and 1990-2014.

If you happened to retire in 1972 made 5% annual withdrawals (inflation adjusted) until 1989, if you had been invested 50% in total international and 50% in US stocks (vs. 100% in US), you would have ended up with 3.8X as much in stocks. Your maximum annual drawdown (including the withdrawal) would have been 42.2% vs. 48.2%.

Flash forward. If you happened to retire in 1990, right after the Japan bust, and made 5% inflation-adjusted withdrawals until 2014, you would have ended up with 2.5X more if you had been 100% in US stocks compared to having half in total international. Your maximum drawdown would have been 46.5% with US vs. 49.9% with US/International.

Obviously, there has been a wide range of outcomes for retirees from international diversification. Couple of takeaways: when you are taking money out of your portfolio instead of putting it in, over a relatively short time horizon of 20-25 years, you have to plan based on worse-case scenarios, not what you hope will happen. Second, which of the two historical scenarios do you think is more likely going forward? The one in which international investing was not on the radar and was virgin territory for investors? Or the one representing the last two decades which was just the opposite?
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by BlueEars »

Browser wrote:...
Obviously, there has been a wide range of outcomes for retirees from international diversification. Couple of takeaways: when you are taking money out of your portfolio instead of putting it in, over a relatively short time horizon of 20-25 years, you have to plan based on worse-case scenarios, not what you hope will happen.
Good point. One can use the VPW tool to see this since it has variables like international and retirement start date. 1968 was a bad retirement start year but it probably doesn't tell us much about how the US versus international returns would factor into the future even with the VPW info. Still, VPW is a good first cut.
Second, which of the two historical scenarios do you think is more likely going forward? The one in which international investing was not on the radar and was virgin territory for investors? Or the one representing the last two decades which was just the opposite?
Another good point. In this case one's forward historical concerns and budgetary constraints and age must be considered regardless of what the backward looking VPW tool says.
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by Browser »

Another consideration that has been running through my mind. We're familiar with the "age in bonds" guideline suggested by Bogle. The idea behind this is that as you get older, you have less and less time to recover financially from a bad turn of events; therefore, you should increase the margin of safety as you age. Seems to me the same logic applies to international diversification. We never know whether it will help or hurt returns over any given time period. Even if we assume that over the long run it will help, we don't know what can happen over the short run. Maybe there should be an age-based guideline regarding international investing as well; the shorter your time horizon, the less additional risk (such as currency risk, sovereign risk, political risk) you should be taking with your investments as well.

Ask yourself this: if I knew I only had 5 years left, how much would I put into international investments? A lot of us would probably say zero. How about 10 years, or 15 years, or 20 years? As we know, it can take 20 years or longer for an investment strategy to pay off, and it can turn down before it turns up. If your time horizon is less than 20 years, should you put anything into international? Are you prepared to maintain that allocation for the next decade or two? If not, should you be investing internationally at all?
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by vested1 »

After reading all the recent threads I'd like to say thank you, especially to Nisiprius, who as usual has given cogent explanations that are easily understood. Then again it may be because I agree with his appraisal concerning the need for international exposure. Like others, I was disappointed in the performance of VTIAX, Total International Stock last year. I spoke recently with Fidelity and Vanguard CFP's on the subject and they both urged a larger AA to both international stocks and bonds. Their reasoning was identical, in that the monetary easing policy has only recently begun in foreign markets, while the U.S. is winding down it's practice of doing so with the suppression of interest rates. In theory, the effect of the newly adopted policy should mean better returns for international markets.

That's all well and good, but in my mind, changing AA because of backtesting or future predictions could get an unsophisticated investor like me in trouble. I'm going to stick with 17% of my stocks in international (10% of portfolio), and 20% of my bonds in international (8% of portfolio) with a combined 60/40 AA. This could work out well, or could be less than optimal, but who can tell?

The key for me is that adding in a couple slices of international provides more diversification. I'm willing to give up a little gain for a bit more safety, and even though international is considered more aggressive when used in excess, it mitigates the affect of cycles in the graphs previously presented.
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by kolea »

Browser wrote: Ask yourself this: if I knew I only had 5 years left, how much would I put into international investments? A lot of us would probably say zero. How about 10 years, or 15 years, or 20 years? As we know, it can take 20 years or longer for an investment strategy to pay off, and it can turn down before it turns up. If your time horizon is less than 20 years, should you put anything into international? Are you prepared to maintain that allocation for the next decade or two? If not, should you be investing internationally at all?
And this illustrates my chief complaint of using standard deviation as the definitive measure of risk - it does not account at all for the time-to-recover aspect of major market downturns, yet recovery time is more important than the magnitude of the drop.

At any rate, your point is a good one and is equally applicable to other models that have long time horizons to bear fruit (think: SCV).
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by Browser »

TwoByFour wrote:
Browser wrote: Ask yourself this: if I knew I only had 5 years left, how much would I put into international investments? A lot of us would probably say zero. How about 10 years, or 15 years, or 20 years? As we know, it can take 20 years or longer for an investment strategy to pay off, and it can turn down before it turns up. If your time horizon is less than 20 years, should you put anything into international? Are you prepared to maintain that allocation for the next decade or two? If not, should you be investing internationally at all?
And this illustrates my chief complaint of using standard deviation as the definitive measure of risk - it does not account at all for the time-to-recover aspect of major market downturns, yet recovery time is more important than the magnitude of the drop.

At any rate, your point is a good one and is equally applicable to other models that have long time horizons to bear fruit (think: SCV).
We generally think of "tracking error" as the discrepancy between the returns of some given equity allocation strategy vs. TSM. The risk of tracking error is the risk of giving up and bailing out on the alternative allocation strategy before it bears fruit, which could be never or could be 20+ years. Recent thread by Robert T. on balancing the higher expected returns from tilting with tracking error risk. Same consideration applies to international diversification. Tracking error risk cuts a little deeper during retirement, when you are sucking money out of your portfolio for living expenses and you have a fairly short time horizon to play with. For that reason, retirees should probably think a little longer about whether and how much to allocate alternatively, including internationally. At least for them, Bogle might right: think about investing nothing in international, or if you must maybe no more than about 20% of your equity allocation. Accumulators might be in a stronger position to disagree.
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chessmannextmove
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by chessmannextmove »

z3r0c00l wrote:Currency risk = currency diversification. International isn't beneficial if domestic does better. If domestic tanks a year before retirement, suddenly international may be helpful. If you are not disappointed by at least one investment at any given time, diversification is not working.

I can't imagine this argument being true; one counts on a domestic economy for a job, housing, retirement, public services, and then intends to put all of his money in domestic too?
Unless you plan on living substantially long periods of time in other countries, why do you need to diversify currency?
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Browser
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Re: Foreign stocks/bonds may be less beneficial for retirees

Post by Browser »

chessmannextmove wrote:
z3r0c00l wrote:Currency risk = currency diversification. International isn't beneficial if domestic does better. If domestic tanks a year before retirement, suddenly international may be helpful. If you are not disappointed by at least one investment at any given time, diversification is not working.

I can't imagine this argument being true; one counts on a domestic economy for a job, housing, retirement, public services, and then intends to put all of his money in domestic too?
Unless you plan on living substantially long periods of time in other countries, why do you need to diversify currency?
Good point. The reason that investing foreign securities can entail currency risk for a domestic investor is that you invest dollars, which are then used to purchase foreign-currency denominated securities (entailing a conversion to those currencies), and then when you liquidate those investments to spend the money in dollars there is a second conversion back to dollars. The round trip entails currency risk because the exchange rate between the USD and other currencies will change during the journey. It may change in your favor, or to your disadvantage. Since this is an additional investment risk with no expected positive return, it is a risk that, according to MPT, a perfectly logical investor who invests money in dollars and spends money in dollars should avoid. This would seem to be particularly true for US-based retirees, who are in fact regularly liquidating their investments and spending the proceeds in dollars. It would be the same for any investor regardless of country of domicile and home currency. Now, an retiree might want to diversify their investments internationally because they think it makes sense to do that; but the investor should recognize that taking uncompensated currency or exchange-rate risk is part of the deal. If I'm constantly liquidating my investments to spend the cash in my home currency, that is a bigger factor than if I'm adding to my investments over time.
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