Investors have seen significant rewards over the last 15 years by primarily investing in the S&P 500. Portfolios that are cap-weighted and growth-oriented have historically outperformed, leading to an assumption that this trend will continue. However, this perspective poses risks, particularly as the focus shifts from outperforming benchmarks to ensuring sustainable retirement income.
When evaluating performance in terms of absolute returns for retirement, the dynamics change. Drawdowns and volatility become more crucial, as the sequence of returns can greatly impact long-term financial stability, especially during withdrawal phases.
An analysis of rolling 15-year data across various US equity styles posed three essential questions regarding retirement outcomes: the influence of trailing returns on future expectations, the likelihood of different portfolios meeting an 8% annual return target, and the impact of withdrawals on drawdown risk.
Historical trends suggest a significant inverse relationship for cap-weighted and growth portfolios. While these portfolios exhibited high returns over the past 15 years, future expectations are much lower. In contrast, diversified, value-focused, or defensive portfolios tend to offer more stable, lower-risk outcomes, even if they do not capture the highest returns.
Many retirement plans typically rely on an 8% annual return from equities, a critical benchmark for long-term sustainability. The analysis reveals that while cap-weighted portfolios had periods of sub-8% returns, diversified approaches had significantly lower failure rates in meeting this target.
The findings underscore the higher risks associated with cap-weighted portfolios, particularly during retirement withdrawals, where sequence-of-returns risk becomes pivotal. Diversified strategies, by contrast, provide better support for consistent income generation, helping retirees navigate periods of market volatility.
Why this story matters: The shift in investment focus has significant implications for retirement planning.
Key takeaway: Diversified and value-oriented portfolios are more likely to meet crucial long-term income targets.
Opposing viewpoint: Some argue that cap-weighted portfolios may rebound after periods of underperformance, still presenting a viable investment strategy.
