Conventional wisdom teaches investors to buy stocks when they are young, then gradually rebalance their portfolios to favor bonds as they age. That thinking has made target date funds popular. For context, target date funds blend stocks and bonds at different ratios, slowly moving from stock-focused to bond-focused over time.
The 60-40 portfolio (60% stocks and 40% bonds) is a popular alternative to target date funds. That strategy offers the benefit of more reliable returns over time, and it avoids becoming too conservative in retirement. In general, stocks and bonds tend to move in opposite directions, such that a 60-40 portfolio should limit downside in all market environments.
However, a recent study by a group of academics representing three universities examined whether target date funds and 60-40 strategies are truly a better option than an all-stock approach. Here's what investors should know.
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The study compared all-stock strategies, target date funds, and 60-40 portfolios
Before discussing the results, readers should understand how the authors conducted the study, which investment strategies they considered, and how they evaluated those strategies.
The study assumed individuals save 10% of their income during a 40-year period beginning at age 25, and it accounted for possible unemployment during that time. The study then assumed individuals retire at age 65, at which point they withdraw money based on the 4% rule. For context, the 4% rule stipulates that individuals withdraw 4% of their savings in the first year of retirement, and then adjust that amount for inflation in subsequent years.
Guided by those assumptions, the study ran 1 million simulations based on returns data from domestic stocks, international stocks, bonds, and Treasury bills to evaluate several asset allocation strategies, including 1. target date funds, 2. balanced 60-40 portfolios comprising 60% domestic stocks and 40% bonds, 3. domestic-stock portfolios, and 4. balanced 50-50 stock portfolios comprising 50% domestic stocks and 50% international stocks.
The authors evaluated those strategies based on three retirement outcomes: 1. wealth at retirement, 2. income during retirement, and 3. wealth at death. The study also examined the worst peak-to-trough drawdown during working years and retirement years, and the authors discussed the probability of financial ruin with each strategy.
Stocks create more wealth than blended investment strategies
The headline is that all-stock portfolios outperformed the other investment strategies across all retirement outcomes. In fact, the authors stated that "bonds add virtually no value for the lifecycle investors we consider." The results for all three retirement outcomes are discussed below.
Wealth at retirement: The 50-50 stock portfolio performed best, creating $1.07 million in average wealth by retirement, while the domestic stock portfolio created $1.05 million. Both all-stock strategies dominated other asset allocation options, as shown in the table below.
Investment Strategy
Average Wealth at Retirement
50-50 stock portfolio
$1.07 million
Domestic-stock portfolio
$1.05 million
Target date fund
$810,000
60-40 portfolio
$760,000
Data source: Beyond the Status Quo: A Critical Assessment of Lifecycle Investment Advice (Oct. 2, 2023), by Aizhan Anarkulova, Scott Cederburg, and Michael S. O'Doherty.
As a caveat, all-stock strategies led to larger drawdowns during working years, meaning they were subject to greater volatility. But the end result remains unchanged. The average all-stock portfolio created more wealth by retirement than other investment strategies.
Income during retirement: The authors reported income replacement rates, defined as the average consumption during retirement divided by the average income during working years. For instance, the 50-50 stock portfolio had an average income replacement rate of 1.24, meaning it supported 24% more spending in retirement as compared to working years.
Investment Strategy
Income Replacement Rate
50-50 stock portfolio
1.24
Domestic-stock portfolio
1.20
Target date fund
1.06
60-40 portfolio
1.02
Data source: Beyond the Status Quo: A Critical Assessment of Lifecycle Investment Advice (Oct. 2, 2023), by Aizhan Anarkulova, Scott Cederburg, and Michael S. O'Doherty.
Once again, all-stock strategies led to larger drawdowns, meaning they were subject to greater volatility. But the bottom line remains the same: The average all-stock portfolio provided more income in retirement than other investment strategies.
Wealth at death: The 50-50 stock portfolio performed best, producing $2.97 million in average wealth at death, while the domestic stock portfolio generated $2.81 million. Both all-stock strategies more than doubled the performance of the other investment strategies, as shown in the table below.
Investment Strategy
Wealth at Death
50-50 stock portfolio
$2.97 million
Domestic-stock portfolio
$2.81 million
Target date fund
$860,000
60-40 portfolio
$1.3 million
Data source: Beyond the Status Quo: A Critical Assessment of Lifecycle Investment Advice (Oct. 2, 2023), by Aizhan Anarkulova, Scott Cederburg, and Michael S. O'Doherty.
Finally, the study examined the probability of financial ruin, defined as the depletion of savings before death. Somewhat surprisingly, the 50-50 stock portfolio had the lowest likelihood of financial ruin at 8.2%. The 60-40 portfolio had the second-lowest potential of financial ruin at 15.7%, followed by the target date fund at 16.9%. And the domestic stock portfolio had the greatest probability of financial ruin at 17.4%.
Investors should consider their own risk tolerance
Statistically speaking, the all-stock portfolios created more wealth at all stages of life as compared to target date funds and 60-40 portfolios. In other words, the average investor who allocates their portfolio to stocks would accumulate more money by retirement, have more of their income replaced during retirement, and pass more money to the next generation as compared to the average investor who adopts a different strategy.
That said, the study also found that all-stock strategies suffered greater declines, and the domestic stock portfolio had the highest probability of financial ruin. Peace of mind is priceless. Some investors would gladly exchange outperformance for reduced volatility. In those situations, target date funds and 60-40 portfolios are excellent options.
How to get exposure to domestic and international stocks
Readers may wonder how to get exposure to domestic or international stocks. Personally, my choice for domestic stocks is an S&P 500 index fund like the Vanguard S&P 500 ETF(NYSEMKT: VOO). Warren Buffett himself has frequently recommended that strategy. But investors could also consider the Vanguard Total Stock Market ETF(NYSEMKT: VTI).
What's the difference? The Vanguard S&P 500 ETF tracks 500 large U.S. companies that cover about 80% of the domestic equity market by value, while the Vanguard Total Stock Market ETF tracks more than 3,700 U.S. companies in an effort to cover the entire domestic equity market.
For international stocks, investors should consider the Vanguard Total International Stock ETF(NASDAQ: VXUS), which tracks about 8,500 companies. Those businesses are primarily spread across Europe (40%), the Asia-Pacific region (27%), and certain emerging markets (25%), though a small portion are based in North America (8%).
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Trevor Jennewine has positions in Vanguard S&P 500 ETF. The Motley Fool has positions in and recommends Vanguard Index Funds-Vanguard Total Stock Market ETF, Vanguard S&P 500 ETF, and Vanguard Star Funds-Vanguard Total International Stock ETF. The Motley Fool has a disclosure policy.
