Retirement Asset Allocation Simulation Study

Disclaimer

• This analysis is for informational and educational purposes only.

• There could be bugs in our programmatic analysis. We are not liable for any actions you take as a result of anything you read below. Please conduct your own due diligence before making investment decisions.

• Any decisions influenced by the information in this analysis are made at your own risk.

Overview

This analysis attempts a data driven answer for the following questions as they pertain to retirement asset allocation:

• Is there an optimal way to allocate savings between stocks and bonds while saving for retirement?

• Is the optimization different once you’re in retirement?

• What are the tradeoffs between different approaches?

To answer these questions, we will use historic stock, bond, and inflation data to simulate (back-test) different asset allocations and compare outcomes.

Note: All references to “stocks” and “bonds” should be interpreted to mean index funds of stocks and bonds rather than individual stocks (e.g. Google (GOOGL), Amazon (AMZN), Apple (AAPL), Deere and Co. (DE)) or bonds.

Data

Three data sources were used in this analysis:

• S&P 500 Total Return (price changes plus dividends, used to represent the stock portion of asset allocations)

  • https://www.slickcharts.com/sp500/returns

• 10 Year Government Bond Returns (used to represent the bond portion of asset allocations)

  • http://www.econ.yale.edu/~shiller/data.htm

• Consumer Price Index (CPI) (used to make inflation adjustments to dollar values)

  • https://data.bls.gov/timeseries/CUUR0000SA0?years_option=all_years

It would have been preferable to use a bond index fund instead of 10 Year Government Bonds, but we couldn’t find any long-term return data for bond index funds.

Below are annualized summary plots of the three data sources.

Working / Saving Asset Allocation Results

The following assumptions were used for the working / saving asset allocation simulation:

• Working career of 40 years

• Starting retirement savings of $0

• Starting salary of $80,000 per year

• Annual raises during the first 15 years are 4%

• Annual raises during the final 25 years are 2.5%

• Retirement savings rate of 15% of annual salary

• All investment returns are reinvested

• One 40-year simulation will be run starting each year from 1926 to 1983

• All plot and table values will be inflation adjusted to 2023 dollars

• 20% increments will be used for stock / bond asset allocation (100% stock / 0% bond, 80% stock / 20% bond, etc.)

In the plots below, each gray line represents the simulation for a single start year. The red line is the mean value across all the simulated start years; the blue line is the median value across all the simulated start years. These plots can be confusing at first glance. If this type of plot is unfamiliar to you, it might help to just look at the best case at the end, the worst-case at the end, and the average; be sure to pay close attention to the vertical axis scale which changes from one plot to the next.

Working / Saving Final Values

100% Stock - 0% Bond, Descending

80% Stock - 20% Bond, Descending

60% Stock - 40% Bond, Descending

40% Stock - 60% Bond, Descending

20% Stock - 80% Bond, Descending

0% Stock - 100% Bond, Descending

Working / Saving Comparison Plots

Next, we will compare the mean and median performance between the different asset allocations.

Now that we’ve compared the range of outcomes and average performance for each asset allocation, let’s look at how the worst-case scenarios compare. For this simulation, the worst time to start working with a 100% stock allocation was in 1969.

Retirement / Spending Asset Allocation Results

The following assumptions were used for the working / saving asset allocation simulation:

• Retirement length of 30 years

• Starting retirement savings of $2.5M

• Annual spending of $100,000 per year (4% of retirement savings)

• All investment returns are reinvested

• One 30-year simulation will be run starting each year from 1926 to 1993

• All plot and table values will be inflation adjusted to 2023 dollars

• 20% increments will be used for stock / bond asset allocation (100% stock / 0% bond, 80% stock / 20% bond, etc.)

In the plots below below, each gray line represents the simulation for a single start year. The red line is the mean value across all the simulated start years; the blue line is the median value across all the simulated start years.

Retirement / Spending Final Values

100% Stock - 0% Bond, Descending

80% Stock - 20% Bond, Descending

60% Stock - 40% Bond, Descending

40% Stock - 60% Bond, Descending

20% Stock - 80% Bond, Descending

0% Stock - 100% Bond, Descending

Retirement / Spending Comparison Plots

Next, we will compare the mean and median performance between the different asset allocations.

Now that we’ve compared the range of outcomes and average performance for each asset allocation, let’s look at how the worst-case scenarios compare. For this simulation, the worst time to retire with a 100% stock allocation was in 1929 (at the beginning of the Great Depression).

Conclusions

The following conclusions should be interpreted within the confines of the simulation assumptions described in the working / saving and retirement / spending sections above.

• During both the working / saving and retirement / spending years, there is a trade-off between volatility and return.

  • Higher stock allocations result in more volatility and higher total savings.

  • Higher bond allocations result in less volatility and lower total savings.

• Higher stock allocations during the working years increases the chance of being able to retire early. Higher bond allocations during the working years increase the chance of not having enough money to retire on.

• Each 20% increase in stock allocation during the working / saving years increased average retirement savings by about $350k over a 40-year career.

• During the worst-case scenario for the working / saving years (starting to work in 1969), higher bond allocations resulted in lower retirement savings over a 40 year career.

• Higher stock allocations in retirement resulted in a continually increasing average retirement savings value at the 4% spending rate.

• Each 20% increase in stock allocation during the retirement / spending years increased average retirement savings by about $2.5M after a 30-year retirement.

• During the worst-case scenario for the retirement / spending years (retiring in 1929 at the beginning of the Great Depression), a 60% stock / 40% bond allocation resulted in the highest retirement savings value after a 30 year retirement.

• The analysis didn’t make the final editing cut, but “own your age in bonds” results in an average performance roughly equivalent to 50% stocks and 50% bonds in both the working / saving and retirement / spending years.

• As you’ve likely heard countless times before, continually investing and reinvesting over a long period of time is crucial to achieving substantial retirement savings. In our working / saving simulations, retirement savings increased more in the last 10 working years than in the first 30 (independent of asset allocation).

• Everything else held constant, the year you start saving for retirement and the year you retire have a huge influence on your retirement savings.

  • In the most extreme working / saving scenario (100% Stock - 0% Bond), the difference was $6.4M after a 40-year career. Specifically, if you start working / saving in 1969, you end up with $1.2M; if you start working / saving in 1926, you end up with $7.6M

  • In the most extreme retirement / spending scenario (100% Stock - 0% Bond), the difference was $34.2M after a 30-year retirement. Specifically, if you start retirement / spending in 1929, you run out of money; if you start retirement / spending in 1942, you end up with $34.2M.