Fremdon Ferndock wrote: ↑Tue Jan 18, 2022 11:06 am
I don't think assuming a real yield lower than 0% changes the essential finding of the study -- which is that
a lower equity risk premium makes stocks less attractive for retirees going forward. The expected return is lower, but the expected volatility and downside risk haven't diminished.
I am not sure the equity risk premium is lower than its historical equity risk premium. The best source for historical equity risk premium I have found is Dr. Aswath Damodaran of NYU who has estimated historical equity risk premiums back to 1960. According to him, the current equity risk premium is 4.24%, which is higher than it was in the 1990s and early 2000s (pre GFC). I am not able to copy the chart, but one can find it by clicking on the link "2. Implied ERP (annual) from 1960 to Current" from the link below which will open an excel spreadsheet. The Tab "Implied Premiums" has a chart with the ERP going back to 1960.
http://pages.stern.nyu.edu/~adamodar/
The challenge is low bond yields which make absolute returns on everything low, which is compounded by assuming historical volatility of stocks during drawdown. Even with a 4.24% ERP as of 12/31/21, with a 10-year treasury of 1.51% as of that date, the total nominal expected equity return was 5.75%.
I agree with the author's conclusion however:
"Reacting to the prospect of a lower-than-historical investment returns and a lower risk premium from stock investing (sic) creates a dilemma for clients and advisors – whether to invest more heavily in stocks to increase expected cash flows and bequests or take a more defensive posture and reduce the equity allocation to hold down the negatives.
For practitioners, this analysis would need to focus on customized projections that reflect client specifics. For example, if a client has a solid base of lifetime income from Social Security and perhaps pensions or annuities, such income may be enough to cover basic living expenses and make it easier to tolerate a higher equity allocation for the investment portfolio. But if a client has more limited lifetime income sources, the negatives discussed above will loom larger, and the best approach might be to use a lower stock allocation. It may also be worth exploring delaying Social Security and other options such as an annuity (e.g., a SPIA) or setting up a reverse mortgage to provide more secure lifetime cash flow and reduce potential damage from poor investment performance."
FWIW, I am nearing early retirement in my 50s with a 60%/40% allocation. I am definitely not loading up on equities but there is also a significant risk of being underweight equities for a longer retirement.