ELAINE: Yeah! He is a friend, Jerry. He is reliable. He is considerate. He's like your, exact opposite.
JERRY: So he's Bizarro Jerry!
ELAINE: Bizarro Jerry?
JERRY: Yeah. Like Bizarro Superman. Superman's exact opposite, who lives in the backwards bizarro world. Up is Down. Down is Up. He says "Hello" when he leaves, "Good bye" when he arrives.
- Seinfeld, "The Bizarro Jerry," Season 8, Episode 3.
Let's make some very broad assumptions and assume you save 20% of your income every year, invest in global equities and US Treasuries, and follow a normal path of income growth over your career for high earners. What portfolio should you hold while you're working?
It turns out that an all-equity portfolio leads to the best results in all but the worst possible outcomes. Fixed income portfolios do the worst across the board.
The table below has terminal portfolio values, specified as multiples of final year income, based on 500 random trials using historical data. Everything is in inflation-adjusted terms.
Figure 1: Heat map of terminal values for various stock/bond allocations
Focusing on the all-equity column, the best-case outcomes are superior, the median outcomes are superior, and even the 25th percentile outcomes are as good as any of the other portfolios. When you're saving for 30+ years, fixed income is risky and equities are safe! This is the backwards bizarro world compared to the typical mindset that "bonds are safe and equities are risky."
The problem, of course, is the worst case outcome for equities (still better than all fixed income though). We have to find a way to take advantage of the equity-return premium while mitigating the worst-case outcomes, and simply holding a less-volatile portfolio throughout your working career is not the optimal solution. Pension funds can teach us a really important lesson in that regard. More on that in a future post.
Michael Crook, Head Americas Investment Strategy, UBS Financial Services Inc. (UBS FS)
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