Stocks, Bonds, or a Cash Wedge — What's Right for Your Retirement?

In this episode, Evan and Sam explore new research challenging the conventional wisdom of shifting to bonds as you near retirement, making the case that a globally diversified equity portfolio — tailored to your personal risk tolerance, capacity, and financial needs — may actually give you better odds of reaching your retirement goals. 

📱 Book an intro call - Cedar Point Pathway retirement planning service

📝Financial Foundations Scorecard - See how you score in the areas of cashflow & spending,  saving & investing, debt & risk protection, and retirement readiness. Instant feedback and recommendations on how to improve your finances.

Transcript

SPEAKER_00 0:00

A common belief when it comes to preparing your retirement accounts for that inevitable day when you do retire is that you should be getting more conservative with your investment portfolio. This is called the changing your asset allocation, just that combination of stocks, bonds, and cash to make sure that you're still able to meet your goals while feeling comfortable and confident enough in the portfolio to be able to do that. So today we're talking about asset allocation and some common things you might have heard and perhaps what the research is saying about how you should be adjusting your asset allocation over time. So let's get right into it right here on the Canadian Money Roadmap Podcast. So, Sam, maybe some common thoughts around asset allocation as you get closer to retirement suggests that you should be decreasing the amount of stocks that you have in your portfolio. You know, this is pretty common and it's it might be just fine. Maybe you walk me through some of the common approaches that are out there for adjusting asset allocation as it relates to one's retirement date and throughout their retirement years.

SPEAKER_01 1:07

Yeah, so I think we we often see that, you know, early in our accumulation years when we're investing, people are typically kind of you know in near uh 100% equities and 100% stocks at those times. But over time, we often see, you know, uh products included in portfolios to reduce the risk that people are taking on in their investing portfolios. And so this is commonly done with reducing some of those equities with bonds. And the target date fund is something that is that is interesting, but kind of is uh an example of how this works. So over time, these target date funds they might start with 100% equities and over time at specific intervals, they kind of reduce the number of equities and introduce some bonds and maybe some cash at different points in time.

SPEAKER_00 1:56

Yeah, if you have money invested with a defined contribution pension plan or P matching plan at your work, chances are pretty good that this is at least an option for you in those plans, meaning a target date fund. And so, yeah, like Sam said, the way that these work, sometimes they're called like a glide path fund, something like that, where essentially the idea is that it just gets more conservative as you get closer to that target date. And when those products exist in your retirement accounts, generally the default allocation is based on your age 65. Every brand, like every company that offers these, has a different version and interpretation of this and how conservative they get versus the timelines in which they do it. And so, you know, there's not really an exact science, but all of them are kind of subscribing to that same concept of well, as you get closer to that retirement date, you should get some more conservative, meaning you should own less stocks and own more bonds, maybe some more cash potentially, so that it reduces the volatility as you get closer to that target date.

SPEAKER_01 3:04

One thing we want to talk about today is just so this is some, I would say, commonly held beliefs about investing. You know, over time, by adding more bonds and adding more cash, you reduce your volatility and your risk over time. But it turns out that might not, it might not be as simple as that in many cases. And that's what bring that brings us to some interesting research that's been done over the last two years, basically, by Scott Sederberg and some colleagues that is really challenging some of these assumptions about investing.

SPEAKER_00 3:36

Yeah, you know, the idea of risk is interesting. Like you can take a look at risk from a variety of different standpoints. Again, that's not the the main concept that we're trying to get across today, but volatility. Some probably argue that that isn't actually true risk. That's just kind of you know what the ride looks like along the way. A lot more people these days are seeing risk as more the inability to reach one's goals or have positive returns over a period of time. And so Scott Sederberg's research has kind of introduced the idea of diversification within equities as being a little bit more of that risk-mitigating technique that you should be doing, primarily instead of looping in bonds as a primary method of reducing risk or volatility within the portfolio. So maybe walk me through some of the high-level things from the research there and we can get into it a little bit.

SPEAKER_01 4:36

Yeah. So as you're alluding to, Evan, I found this very kind of fascinating research and really just interesting because it's it at the very least forces financial planners and people investing to maybe rethink some of these deeply held assumptions. But the basic premise is that by maintaining your investments in one-third domestic stocks and two-thirds international stocks throughout your retirement, you have a better chance of receiving or realizing higher returns or having a you know a larger sum at the end. Also, it decreases your chance or your probability of ruin as well. So the main kind of takeaway or the main assertion they're making is that really by having internationally diversified equities, you do come out ahead in the end rather than kind of switching to to bonds and and diversifying with bonds and cash through your retirement.

SPEAKER_00 5:30

Yeah, this is this is pretty cool. Like from my perspective, too, like looking back on this research, truthfully, I I looked at the paper about a year or so ago and it came out. And and so you you've got the more recent reading of the details on it. But my high-level takeaway was essentially like this is encouraging to hear that if you're investing in assets that have higher expected returns over time, like stocks over bonds, once they've kind of fleshed this out with I don't know how many thousands of different simulations they did over different countries and things like this. Do you recall?

SPEAKER_01 6:08

I don't actually have it off the top of my head, Evan, but we can look at that. But it was thousands of simulations and scenarios that they were running through.

SPEAKER_00 6:15

Right, because they're they're also inferring that domestic stocks are domestic for the country of origin that they might be simulating at any given point, right? So if it's a Canadian biased portfolio, Canada's the domestic stocks, US, you know, any European country, you know, all these different kinds of things. So thousands of simulations. It was encouraging for me to see that the you know the strategy has has played out where if you have higher expected returns over enough periods of time, these actually turn into higher realized returns. Great. But you know, you know, seeing these scenarios where the the probability of ruin, meaning like one might think of like, I don't know, I still keep hearing stories from people of like, oh, my parents lost everything in 2008 or whatever the scenario was, or they got burned during COVID by investing in the wrong things, or you know, whatever the situation is. But by owning this diversified portfolio with that reasonable amount of home bias, but also enough international exposure, the probability of ruin actually declined with the equity portfolio versus one that introduced more fixed income.

SPEAKER_01 7:33

Yeah, and that's you know, one thing that stood out to me from one of the It was a shorter article kind of where Cederberg and some of his colleagues were being interviewed about their findings. And he made a good point where about the correlation between domestic stocks and bonds. And he he said that you know, if domestic stocks lose over a 30-year period, the chance that bonds show losses relative to inflation are also is also about 65%. So that's getting into that, you know, the minutia of some of this, but just some correlation between domestic stocks and bonds that don't make it necessarily the best hedge or kind of volatility diminisher that you ideally would want it to be.

SPEAKER_00 8:14

Right. And so I guess the the the takeaway there is that if there's enough positive correlation between stocks and bonds over enough period sets, like they're not negatively correlated as much as as people might make them out to be. If there's positive correlation, but they just have lower expected returns, then you know, inevitably when you have those periods of decline, you know, you're just not able to get enough juice to be able to offset that that gap in the returns between the the equities and the fixed income.

SPEAKER_01 8:47

That's where this diversifying with a blend of domestic and international stocks, their scenarios indicate that it do a better job of this. And so it's like the best outcomes are better when you diversify international and diversified stocks, but also the worst outcomes are better. So it's kind of like the best of both worlds, which is which is interesting.

SPEAKER_00 9:06

Interesting. So like the the bottom, like the the worst outcomes in both like allocations were actually higher in the diversified equity.

SPEAKER_01 9:16

Yeah, and that's getting into that probability of rule ruin, excuse me, you know, studies they did, like the the diversified international domestic stocks actually had lower probabilities of ruin based on comparable other kind of target date funds and things like that. So it's so that's very compelling, right? It's like if we can have a higher expected return, but also have a lower probability of ruin, that's that's exactly where we want to be.

SPEAKER_00 9:40

That's interesting. Yeah. So you know, so this is suggesting that people would largely be better off by investing in all equity portfolios throughout their life cycle. Now, I've I have listened to a podcast or two with Scott Cederberg where the the obvious next question is, well, why doesn't everybody just do that? And I recall one of his answers being along the lines of, well, you know, we're we're simulating spreadsheet numbers, not real people in the real world. Right. And so once we get a little bit of human emotion, the ability to stick with this all equity portfolio throughout one's life, it's not always realistic. For some people it it is, and it's totally fine, and they likely have better outcomes over time. But you know, if if you can't stick with it throughout the ups and downs that inevitably come with that, even though we can look at you know, from beginning to end results, we have to live that in real time. And that comes with a lot of a lot of this, right? And so if you're someone that can't handle the this part of it and stick it out and keep owning that diversified portfolio, well, maybe that approach actually does introduce more probability of ruin because you're tinkering with it at the wrong time or something to that effect, right?

SPEAKER_01 11:10

Yeah, and I so this is where I think it's the the implementation of this these findings that is particularly interesting. And I don't like I don't think we're advocating that this is a one-size-fits-all certainly approach, but it's just it's compelling to know that to know that the data kind of supports this. But I agree with you 100% in the actual implementation is where we have to put a lot of focus, and that's where the kind of personal finance area comes in. You know, what risk tolerance and profile do individuals have? And, you know, there's some people that maybe this all equities approach over a longer period of time really works well. But also, you know, there is still value in diversifying in different ways if it's going to mean more peace of mind in the short term, because maybe there's less volatility and all those kind of things.

SPEAKER_00 11:56

For sure. I still think that you know sequence of returns matters in real life more than it does in simulations, and even one's own anticipation of sequence of returns, you know, in in the worst-case scenarios, like you know, you retiring and the market crashes, or you, you know, market being down for an extended period of time at your death, or whatever you know, the scenario might be, even thinking about that and worrying about that, that's a real cost that's that's worth considering. So, you know, back to the the personal finance being personal in this case, evaluating your own situation in light of how much money you actually need, I think is really important to start with, because it's like, okay, great, yeah, you might have higher expected or higher realized returns, pardon me, by investing in an all-equity portfolio. But did you need to? Right? Like, maybe you had enough money already. Did you actually have to do that? It's like it's all well and good to look back and say, like, boy, I had the best returns out of anyone in my peer group, and that's going to be on my tombstones. Like, who cares? Like, it it's all about matching your money to what you need it to do or want it to do. And again, we we talk about this all the time that we don't subscribe to the idea that having the biggest pile of money is a goal in and of itself, at least one that's that's worth pursuing. We are in the business here of pursuing how much is enough to be able to meet the objectives that you have. Um, and so once we kind of loop those things in, the conversation gets a little bit messier, right? And so, you know, bonds and cash, I still think have their place once we start talking about real people and and you know, not just the spreadsheet people.

SPEAKER_01 13:49

Yeah, and maybe this is like maybe even taking a step back and looking at this research from a different perspective, it also really reinforces just, I think, an investment approach that you often suggest to people, but just having this internationally diversified portfolio, right? And it really does reinforce that. You know, you can have that conversation about whether actually staying in all all equity, all equities kind of into retirement, whether that actually works in practice for for people, but getting that information about just how significant diversifying internationally with your equities, that's another kind of takeaway from this paper that is maybe a bit, a bit less kind of uh uh aggressive, you know.

SPEAKER_00 14:29

Totally fair point here, because here in Canada, or like those of us in the the world of what we would call like evidence-based investing, um, we're not all there, I guess, but for those of us that subscribe to that idea, we kind of forget. I'm I'm putting my hand up here, uh, we kind of forget that that's not a universal belief. And in particular, this this research is maybe more of an enlightenment moment for those people in the United States who and and perhaps those who subscribe to the you know the the idea that the the United States has this exceptionalism, you know, like they're the only place to invest or the best place to invest. You should have every penny of your money invested in the S P 500. And it's like, well, Warren Buffett said you should put it as SP 500. It's like the concept was right. Like that I don't know if he actually even would believe that exclusively either. But you know, diversifying into international markets as something that we subscribe to is worth mentioning that it is research-backed. And when you look at some of the products that are available, ones that we use with our clients, but also a lot of ones that are now available in a DIY format, like the all-in-one ETFs from a variety of providers like Vanguard and BlackRock, that's pretty much the allocation that they have, right? So it's about a third in domestic equities and the rest in international, which includes the United States and so on. And so that is a research-validated approach of having some home bias, meaning having more Canada than we make up in market caps. I think globally we're between like three and five percent of like global market cap. But in the portfolio, having about a third that also holds out within the research to say that's that's appropriate. But then diversifying outside that. So we shouldn't have everything in Canada, but we also shouldn't have everything international or everything in the United States. This kind of like one-third, two-thirds approach that that we use was validated to some extent, I guess, with with this research. And so again, that's encouraging to me. So even within the portfolios, those all-in-ones that include some fixed income exposure, the amount that is in equities still follows kind of that same international diversification ratio that you know is is kind of the bulk of the, you know, the driver of the returns for the equity portion that you can rely on. Yeah.

SPEAKER_01 16:55

Right. And it's, I mean, it's worth also noting that you know, some of this, the findings from Peterberg and his colleagues is that there are cases on the very top end of returns that, you know, if things go incredibly well where domestic does outperform these portfolios, but the median is much higher for the international kind of diversified stocks or equities, as well as the floor is is higher. So it's like on all those other volatility metrics, you do a lot better when you have this diversification diversification uh across domestic and international.

SPEAKER_00 17:27

And I guess that's kind of what we're mostly worried about, like is people that are trying to make prudent decisions with our money. It's like there's all sorts of ways you can you can buy like financial lottery tickets, right? But it's like we're trying to raise the floor more than we are trying to raise the ceiling, I think. And I hope most people listening to this podcast are kind of doing that same thing. Like, yeah, sure, you could probably buy crypto. You could have bought cases of expensive French wine that have some, you know what I mean? Like, there's all sorts of like crazy things that you could do that would increase your upside potential. We're trying to raise the floor as much as we reasonably can within an evidence-based framework so that we can reliably invest in such a way where we have that backbone of like, well, this has shown to give us the greatest odds of success over time. So because we don't know the future, this is what we're going to try to do to kind of tilt the odds in our favor.

SPEAKER_01 18:21

And I think that it's compelling to, you know, you're talking about these different products that even if they're not all equity ETFs or mutual funds or things like that, but they have some of that fixed income stuff baked into them, but they're still using the same allocation for the equities they have as far as a mix of domestic and international. I think that's interesting. But I was gonna ask, does this does this research make you think about some other ways of going about like maybe keeping money in equities, you know, in this domestic international mix, but then having certain other strategies like a cash wedge or things like that that can kind of work in parallel? Yeah, for sure.

SPEAKER_00 18:58

So I when someone is invested, I try to kind of keep the philosophy the same. But then for us, our approach, maybe I'm gonna get into that. It's like I don't think there's any one right answer that we apply universally for absolutely everyone. The the investing approach is broadly the same, but the specific allocations might be different based on a few different things. So maybe I'll get into our approach here a little bit and some of the things that that we do. So starting with like an evaluation of one's risk preference. So this is like, how does someone feel about volatility? Because there's some people that it just doesn't bother them, like whatever's going on in the markets, it's like they don't get phased by it at all. And so having full equity exposure with the ups and downs that comes with that, they're like, eh, okay, that's fine. I I go about live my life. And that's just okay for them. But then there's other people that, you know, fair enough, they get very nervous when the market drops because they don't know how far it's gonna go or how that's gonna impact them and whatever. And no matter what kind of planning work you do, it's like it still makes them nervous. It's like that's okay, that's being human. That's okay, totally fine. That's not some some fault necessarily, it's just different. And we, you know, we have to treat everybody how they are, and that's all right. You know, are these people watching the financial news every day? Please don't do that. But some people still do it. They're logging into their accounts and checking balances every day or multiple times a day, whatever. These are all things that make me think that they might not have as high of a risk preference tolerance is is another way of saying it too, but just how they feel about the volatility within the account. So if those are present for somebody, yeah, I think including something like a cash wedge is actually quite nice from a psychological standpoint, right? Because it makes people feel like, oh, and sorry, a cash wedge again is just having a sleeve of literally cash. We often use something called a money market fund, something like that. It acts like a high interest savings account where your your balance stays the same, but it just earns a little bit more interest than you'd get from cash in the bank, essentially. So, no, this does not increase your uh expected returns or anything like that, but it is a nice psychological buffer for you to know that even if things are going haywire in the other part of the portfolio, you've got a year or two years worth of cash, and that's the money that we're spending. And for many people that don't have a very high risk tolerance, they like that. And sticking with a plan or a investment strategy instead of trying to go all in, all out and get the timings right and all sorts of garbage that doesn't work, like that might be optimal for that person, right? Like you need to be able to stick with the thing, and a cash wedge is a really nice psychological tool. Bonds can be really nice for somebody as well, and so you know having a balanced portfolio plus a cash wedge might be okay. But in that case, you have to know that your expected returns are going to be quite a bit lower. And so this is where you take a look at say risk need perhaps. And so like how much return do you actually need from your money to make the plan work? And at some point, I've had a couple of clients say like, you know what? I've made my money. Let's take some of this volatility off the table here. I don't need to make the pile bigger. This is my enough you know we can live on this plus government benefits and whatever the case may be I don't want to see it go down a whole lot more. Great. If we run the numbers and we say like you don't actually need to do this, who cares about raising the floor anymore? At this point, it's a personal decision on how much is enough and how much volatility we need to be able to stomach to be able to make everything work.

SPEAKER_01 22:53

Yeah it's maybe worth kind of just referencing the context we're in at the moment because I think that the last few years have been very strong. So it's a lot easier strong returns wise. So it's a lot easier to kind of just like oh let's keep doing it you know let's keep the the all equity approach or something nearing that. And it becomes a lot more difficult if that's not the case and it's a tougher um year or stretch for the markets. And so that's where yeah I think implementing some other strategies in the event that that happens particularly when things have been so good can be a nice way to kind of balance that out and and I think you're definitely seeing that with some of some of the clients you've been dealing with recently.

SPEAKER_00 23:30

For sure. And and part of our job too is to not necessarily pump the tires on on how good things have been. It's like this is great let's just keep going like no like our job is to be like the sober second thought of like you know what I what I've been doing with some people over the last six months to a year is doing periodic fire drills. Like just so you know market's not going to go up 25% a year every single year. Definitely will not at some point this will come back down and that's okay because of this that and the other thing is we've baked it into your plan. We've planned for this this is going to happen at some point I'm not a a doom and gloomer. It's just reality. That's just how this works things can't go straight up all the time new information comes out latest crises of the day will show up and we don't know what that's going to be today. And it's going to feel weird and scary and that's normal. This is going to keep happening. So anyways I've been doing some of those fire drill type of activities with with clients just so that everybody is kind of prepared this too shall pass a little bit and then again it'll kind of turn around and do the the other thing again. So when we look at one's plan you know and and their broad personal situation we also have to look at their risk capacity. So it's like it's one thing for you to feel like ah I don't feel anything when it goes up and down but then for us to take a look as a third party and see their situation from the lens of like well how much can you actually afford here like if things actually do go bad for an extended period of time which they have and can and probably will again it's like are you going to actually be okay with that? Like are you going to run out of money if there's something outside of our control happens at the quote unquote wrong time. And so you know looking at someone even their like their debt picture or things like that, right? Like you need to have enough financial capacity to take on some risk in the first place. It's pressure is a privilege kind of kind of idea where like you need to be in a fortune enough financial situation to reasonably take on additional investment risk for the potential of upside in the first place right and so that's risk capacity I think is really important to consider along with that. So like how much can you handle from like how it feels how much do you actually need and then how much do you have capacity for and so for many people the answer there is not 100% equities. But for many people it's like eh I don't need to make more and for other people eh I don't actually have capacity to take on a whole lot more. I kind of need this money to to be what it is to to make everything work. And and for other people they just get nervous and that's okay. And that's where we start looping in some bonds and maybe a cash wedge or something like that. And it's like okay but the money that we are going to invest we're going to do it in such a way that you're going to get the returns that would be expected for that type of allocation right we we're not trying to add hot sauce to a situation that requires the opposite you know what I mean? So yeah. What's the opposite of hot sauce? I was trying to think of that live and mayonnaise a little bit of ice soup.

SPEAKER_01 26:53

Yeah well we'll work on the analogy but I think also I I I hope that this kind of discussion is giving a sense of kind of how we approach things as well which is we we're trying as best as possible to stay up to date on some of this recent research that is informing kind of an evidence-based approach and be aware of it, but then also blending some of this research and the you know the theoretical ideas about investing with a personalized approach to financial planning. So we can try to meld those as best as possible and come out with a plan that is personalized and works for each individual client that we're working with. And so that it's giving a little kind of a look under the hood of how we build some of this these plans for our clients.

SPEAKER_00 27:36

Yeah and you know we we asked the question off the top of like should you get more conservative as you get closer to retirement and we didn't say it but you know most people that are listening to content like ours from practicing professionals the only answer is it depends. So I hope this last half hour or so was an enough of a a fleshing out of what the it depends depends on. And so you know it all comes back to your situation and why we advocate so much for a personalized approach to finance. So anyways this is how we think about asset allocation at a pretty high level when it comes down to it for an individual client. Things can change over time too a little bit we try not to get you know blown in the wind necessarily about what's going on externally but people's personal circumstance changes and we've seen the loss of a spouse and that can change some things or get a new job and it doubles your income and that kind of changes things or you get a now you have a job with a pension and so now you have more capacity to take on risks because you got to backstop somewhere else. You know all these kinds of things can change over time too and so it's not a set it and forget it. And there should be kind of a constant reevaluation at least a little bit just being aware of how much exposure you have at any given point. And to your earlier point it's like trying not to be a momentum trader with your risk tolerance. It's like when things are really good now I I love risk. It's like no you don't it's like you love returns right it's like we just need to be more and more aware and maybe give yourself that little fire drill exercise of like take a step back things aren't always going to be this good but then if things are bad things aren't always going to be this bad things are going to get better and just try to level yourself out and find that allocation that you can stick with whether that's all equities something closer to cash or bonds or somewhere in between yeah finding that allocation that you can stick with most consistently over time is going to be the best path forward for you.

SPEAKER_01 29:38

Yeah and if you kind of are thinking about this and you want a little resource that can help you know give you a sense of where you're at right now, we've got our Financial Foundation scorecard in the show notes. So you could always check that out. And yeah if you want to have a free intercall with Evan and kind of chat about your situation, I'm sure he would be happy to do that as well.

SPEAKER_00 29:55

Absolutely yeah you can check out the link in the show notes below wherever you're finding this podcast. And we just wanted to say thank you for for listening or for watching wherever you found our podcast today. Thank you so much and we will see you next week on another episode of the Canadian Money Roadmap. Take care. The contents of this podcast do not constitute an offer or solicitation for residents in the United States or any other jurisdiction where Evan Newfeld, Cedar Point Wealth or Sterling Mutuals is not registered or permitted to conduct business. Mutual funds are provided through Sterling Mutuals Inc. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus carefully before investing. Mutual funds are not guaranteed, their values fluctuate frequently and past performance may not be repeated. Financial planning services are provided by Evan Newfeld through Cedar Point Wealth and are not the business of or monitored by Sterling Mutual Speak.