Surveys repeatedly cite retirement as a top source of anxiety for Americans. And that might be for good reason: according to an AARP poll last year, one in five Americans over the age of 50 report having no retirement savings.
Do you know where your finances stand?
When it comes to building a retirement portfolio, many folks don’t know where to start. The reigning retirement narrative has urged citizens to invest in the “high risk, high reward” stock market while they’re young, and slowly allocate more funds to assets like bonds as they age, which are considered the more staid and sturdy option compared to stocks.
But before you trod this well-worn path, Assistant Professor of Finance Aizhan Anarkulova would like to have a word.
Aizhan’s most recent paper on lifecycle investing argues that while the stock market is often characterized as the “sprinter” horse in a race to wealth, it may actually be both the sprinter and steady horse to back in the marathon of long-term wealth accumulation. Her findings have turned heads in the financial sector (and even rubbed some fur the wrong way, as researchers grapple with this up-ending of conventional wisdom).
Aizhan emphasizes that this is still a working paper, and even after publication, people should consult a financial advisor before making any leaps. There is no “one-size-fits-all” approach when it comes to financial planning, although Aizhan does have one piece of advice that should benefit everyone: whatever strategy you land on, save more.
The following interview has been edited for clarity.
Summarize your most recent research paper in six words.
You should invest more in stocks!
What inspired you to pursue a career in this field, and drew you to focus on long-term saving in particular?
My bachelor’s degree is in economics, which opened the door to my interest in finances. After that, I worked as an auditor in accounting, and found the part I liked the most was training the junior hires. Once I realized my passion for helping to create and pass knowledge, I left the corporate world to pursue a Ph.D.
The topics I’m looking at are ambitious; they’re such big economic questions, and the answers would affect almost everyone I know personally. We don’t have a lot of shots at saving for retirement. How many times can you save for 30 years, look at the outcome and say, “oh, that was wrong, next time I’ll change my strategy”? If you’re lucky, you might get two 30-year-windows in your lifetime. But this is why most people benefit from research and data-driven results. It’s a super high stakes question without much room for trial and error.
Your paper specifically uses the term “long term saving.” Does that only mean retirement savings?
My research is definitely relevant to retirement savings and that is likely the scenario most people are imagining when they hear about my research agenda. That said, there are other investments that have long horizons. An individual may be saving over decades to leave an estate behind for their children, or to purchase a business, for example. Or an institution may be looking to maintain an endowment.
This paper studies the optimal lifecycle investment, which also involves on the other half of the equation: withdrawal or “desaving.” We study what kind of portfolio not just produces the highest returns, but is also less risky in the sense that it minimizes the risk of losses.
Your research challenges two widely accepted principles of retirement investing: first, that people should invest in both stocks and bonds. Second, that as they age, they should move more of their money into bonds/cash. Can you explain the rationale behind this conventional wisdom?
The first principle is about the general benefits of diversification. The idea is that stocks and bonds don’t operate in sync: bonds might do better if stocks don’t perform well, and vice versa. We do maintain an argument for diversification in our paper—the principle of “don’t put all your eggs in one basket” still holds true here—but we find you are better off diversifying with international stocks rather than bonds.
Regarding the second principle, I get a lot of questions about this, even in academia. One of the explanations for the second principle is human capital. Here’s what that means: when we’re young, most of us have capital in the form of future earnings because we will work for many years to come. Most likely, you can’t sell it and/or you cannot borrow against it, but it is a form of wealth. With these assumptions in mind, young investors are able to take on more risks with stocks. That human capital diminishes as you get older. That’s why you can afford a larger stock allocation while young— your salary will carry you through the whims of the stock market. You will save again, if something happens, and the stock market will mean revert in the long run. When people are closer to retirement, they may want something “safer” (read it as ‘less volatile’), because they aren’t going to work much longer, and can’t afford to lose their savings anymore.
Did something in particular lead you to question this conventional wisdom—a hunch, a personal experience?
Honestly, we never planned to go against the status quo. We simply let the data speak.
Aizhan Anarkulova
That said, we provide explanations for why we’d gotten that result so I encourage you to read the paper. I’ve published an earlier paper that essentially argues that “stocks are riskier in the long run” than conventionally thought. Then people wanted to follow up, ‘asking ‘if stocks are risky, where should I invest?’ To answer that, we started adding other major assets—bonds, bills, and international stocks—to the portfolios and found that the mix of domestic and international stocks outperforms in our lifecycle setting. So stocks are risky but hey, you have to hold them anyway as long as it is internationally diversified!
What did your paper find to be the most effective strategy in accruing wealth over time?
One third domestic stocks, two thirds international stocks. That is the most optimal ratio for the setting that we consider. We leave some room for how comfortable you are with those weights. The US stock market accounts for about half of the world’s stocks, so you can hold a portfolio that is 50/50 domestic stocks/international stocks. Can you deviate from that exact balance of 1/3 and 2/3? Yes. The point is to have both.
Why is this mix optimal? What should investors consider when adding international equities to their portfolio—what countries? What kinds of stocks?
Our research only considers well diversified portfolios. When we talk about holding international stocks, we are talking about stocks in developed countries. That is, stable markets that are all comparable to the United States and each other. And we’re talking about holding the whole market of a country— an index fund that includes every stock that is publicly traded within that country. When creating an international portfolio, the investments are weighed in proportion to the size or “value” of each country’s stock market relative to the world.
While picking and choosing individual stocks over others may be exciting, that is not the focus of our paper. However, we do imagine you’d need to rebalance your international and domestic periodically, maybe once a year, as the weight of those markets will shift. In our paper, the portfolios are assumed to be rebalanced monthly.
What limitations or uncertainties in your analysis should readers be aware of?
Maybe this question is better for an editor or a referee, because I have a strong sense we did all of this right given our set of assumptions and the empirical setting in the paper. For example, in the base case, we assume investors save 10% of their earnings. But we considered lots (and I mean it) of variations of the base case for each of the assumptions and found that our conclusion holds true.
Our paper is a statistical analysis. What we show is what is most likely to happen, from a statistical standpoint. But we can’t put an exact number on what stock returns will be, say, in the next 30 years; we aren’t fortune tellers.
Can you give us a behind-the-scenes glance into the methodology, in layman’s terms?
In a nutshell, we follow a hypothetical couple in the United States, then we simulate different kinds of income scenarios that happen to people in real life—high income, low income, temporary unemployment, for example—and determine which investment portfolio accrues the largest retirement income and bequest.
We consider a lot of risks that investors face, including job income uncertainty, Social Security income, and the risk of outliving their savings. The model uses Social Security mortality data, calculates benefits based on 2022 rules, and draws on a comprehensive dataset covering returns on domestic stocks, international stocks, government bonds, and government bills from 39 developed countries. Labor income is modeled using findings from a 2021 study by Guvenen, Karahan, Ozkan, and Song, which analyzed real earnings data from millions of U.S. workers provided by the Social Security Administration.
We get to play god for this exercise. We simulate a couple’s life and let them “live” it several times from the beginning to the end.
Aizhan Anarkulova
In those repeat lives, the couple picks different lifecycle investment portfolios, while everything else stays the same. This couple is earning money, they’re saving a certain proportion, they retire at 65, start getting social security, and start taking money from their account. Across the simulated lives, the outcomes are driven by the portfolio that they chose. As mentioned before, we consider lots of variations of the base case and the results are the same. For example, instead of a heterosexual couple, we consider single female and single male, and we also look at same sex couples.
What are the drawbacks to this alternative investment strategy?
We also study what the maximal drawdowns look like for different portfolios. Basically, it’s the largest drop you experience in the value of your portfolio. Maybe the stock market crashes and your million goes to half a million, for example. We look at how that differs across the strategies. If you look at the average of that, then our all-equity optimal portfolios have a larger average maximal drawdown compared to a portfolio with bonds. But if you consider the maximum of the potential drawdowns, then our optimal portfolio is better than the bond-based portfolios. However, drawdown is an intermediate outcome; it’s not something that is affecting your actual wealth as long as you stay invested. If you withdraw money at that low point, you will be worse off. Our analysis assumes you don’t go and sell stocks when the market crashes, you just stay invested.
You have to be able to stick to the strategy you pick and hold it through good times and bad. Ultimately, in the end, it’s going to be better for you. But there’s going to be periods where it hurts.
Aizhan Anarkulova
If you could change one aspect of how people think about investing for retirement, what would it be?
Save more! Everybody should be saving more. At every age. I have to tell it myself, too—I’m like, “you do this research, you know the answer, you know you have to save more.”
What challenges have you faced as a researcher in questioning well-established investment principles, and how have you addressed skepticism?
People have definitely been reactive. We have received a lot of comments and suggestions. “What if you change the retirement age? What if you change the percentage saved?” We have done a lot of additional analyses in this version of the draft to address those comments. I think we’re still facing lots of challenges because it’s an unpublished paper at the moment. When it is published, that’s when it will make the biggest impact and help people.
What questions remain unanswered in your research, and what areas are you most excited to explore next?
In research, the questions never get answered in such a way where it ends the discussion and we move on. When my paper is published, it will beget more questions. So in the future, I’m still likely going to explore the same questions in a sense— the big economic questions are still out there.
What do you find most rewarding about your work in this field?
It’s people. I enjoy building a network with professors across many institutions. I especially enjoy teaching, and my co-workers. Goizueta students are enthusiastic, and they’re really smart. I’ve been very impressed by them.
