Looking Back May Hurt You Moving Forward

ADVERTISEMENT

In one of the Back to the Future movies the villain goes back in time to deliver a book of sports scores to his younger self, who makes a fortune betting on games. Every investor wishes he’d known then what he knows now.

But the conclusions investors may draw from recent events can produce long-term strategies that are worse, not better, according to a study by T. Rowe Price (Stock Quote: TROW), the mutual fund firm.

If you could return to the fall of 2007 and sell your stocks at an all-time high, then miss the collapse that followed by sitting on the sidelines with cash, you’d certainly come out ahead. But since no one has a crystal ball for spotting these drops ahead of time, some investors may conclude it’s best to avoid downturns by using a conservative long-term strategy all the time.

To test that approach, T. Rowe Price looked at how it would have worked out if investors had adopted a highly conservative asset allocation before the downturn of 1973-1974, the last big drop for which there is 30 years of subsequent history. The S&P 500 fell 15% in 1973 and 26% in 1974. That compares to a 57% drop from fall 2007 to March 9, 2009.

The study looked at outcomes of five investment strategies for two investors. The first retired at 65 in 1973 with a $250,000 nest egg and started withdrawals. The second was 45 at the time, had $75,000 put away, invested new sums for 20 more years and then took withdrawals until the end of 2008.

The five approaches start with a “Glide Path” strategy. For the 65-year-old, that begins with 55% of the portfolio in stocks, and gradually reduces it to 20% at age 95. The 45-year-old would start with 85% in stocks and gradually decline to 34% when she reaches 81 at the end of 2008.

The second strategy reduces the starting stock allocation by 10 percentage points, and the third cuts it by 20 points. The fourth strategy invests everything in bonds and the fifth holds it all in cash.

How do the investors do?

In both cases the glide path strategy works best over the long run.

The investor who turned 65 in 1973 would have been better off with nothing but cash until 1985, but sticking with the glide path would have left her with more after that. She would have had just more than $400,000 in 2003, after making withdrawals for 30 years, assuming she took $10,000 out in 1973 and increased the withdrawals every year to match the inflation rate. With the all-cash portfolio, she’d have run out of money in 2001. The other three portfolios would have funded her 30-year retirement, but they’d have left her with substantially less in 2003.

The investor who was 45 in 1973 would have invested another $5,000 that year, and every year would have increased that sum at the inflation rate until retiring at 65 in 1992. After retiring, she would have withdrawn a sum equal to 4% of the balance in the glide path portfolio, increasing it every year to match inflation.

For her, the all-cash portfolio would have been the winner in only 1974 and 1975. Of the five portfolios, the glide path produced the best results from 1980 through 2008. In 2009, when the investor was 81, the glide path portfolio would have had nearly $2.4 million, while the all-cash portfolio would have run dry in 2008.

“While some may insist that an all-cash, all-bonds, or more conservative equity allocation would be better for a retiree than a higher equity allocation, those approaches did not prevail over the long term,” T. Rowe Price concluded.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.

Show Comments

Back to Top