Vanguard recently published a report called, “Penny Saved, Penny Earned.” While the content of Vanguard reports is always interesting, the language is difficult to follow and overly wordy.
Thankfully, this report was summarized by My Money Blog, in a post titled, “Retirement: Saving More Versus Higher Investment Returns”.
To see a list of high yielding CDs go here.
They actually don’t say that you should skip steps one or two. However, their hypothetical analysis suggests that a 25 year old saving 6% of their earnings, with an 80% stock / 20% bond asset allocation, would be financially better-off than a 25 year old saving 9% of their earnings with a 50% stock / 50% bond asset allocation at the age of 65.
You can save 50% less and end-up ahead? That sounds like magic – sign me up.
Well, the projections are based on assumptions about how stocks perform over the long-term.
There is a belief that stocks outperform bonds by several percentage points, when held over long-periods of time. In other words, the only reason why a rational investor holds bonds is to try and soften the impact of big stock market drops.
The idea of the Vanguard piece is that If you can hold stocks long enough, you will come out ahead with the 80% stock portfolio even if there is a large market drop right before you retire. The additional gains from allocating a larger percentage of your portfolio to stocks, should be enough over the long term to offset even a large loss.
As the projections calculated by Vanguard are based on uninterrupted savings starting at 25 with no withdrawals, I think they have little to do with reality. If you shortened the savings time by 12 years, short-term market performance has a far greater impact on returns. At Learn Bonds, we believe a portfolio with 60% stock and 40% bonds creates a nice balance between returns and risk.
While I am critical of Vanguard for this specific research piece, I want to compliment them on exploring these fundamental investing topics which most asset management firms don’t touch.