Risks and Rewards of International Investing for
Retirement Savers
Historical Evidence
Gary Burtless
The Brookings Institution
Washington, DC USA
August 2006
RRC Conference, Washington, DC

 Defined-contribution pension contributors
 Worker control over investment portfolio
 Conversion of savings to level annuity at retirement (age 62)
 Pension replacement rates at retirement
– Alternative portfolios
– With and without overseas investments

Excess sensitivity of pension to late-career returns
Rate of return on contributions
13%
114%
12%
11%
10%
9%
9%
8%
7%
6%
5%
IRR on contributions (left axis)
Pension replacement rate
120%
Geometric mean return over career = 7% .
110%
Replacement rate (right axis)
100%
90%
80%
In exactly one year during career:
Return = -50% .
70%
53%
60%
50%
5.6%
1 4 7 10 13 16 19 22 25 28 31 34 37 40
Year in career with -50% return
40%
In other 39 years:
Return = 9.1% .

Persistence of bad returns
… although not in these 3 countries
Geometric mean return (in US $)
10%
8%
6%
4%
2%
0%
4.3%
9.2%
7.0%
8.5%
U.S.A.
6.0%
7.8%
Australia
1926-1948 1949-1973 1974-2005
Stock returns
7.0%
7.7%
5.7%
Canada

Persistence of bad returns
12%
8%
4%
0%
-4%
-8%
Geometric mean return (in US $)
12.5%
1926-1948 1949-1973 1974-2005
5.4%
7.5%
0.0%
France
6.5%
-6.3%
Ger.
Stock returns
6.3%
3.5%
-1.2%
Italy

Persistence of bad returns
… big time
Geometric mean return (in US $)
0%
-5%
-10%
-15%
20%
15%
10%
5%
1926-1948
1926-1948
-10.2%
-10.2%
15.1%
1949-1989
Japan: Stock returns
1990-2005
-2.9%

High variability of overseas returns
Standard deviation of real stock returns
(in US $)
35
30
25
20
15
10
5
0
19
19
Australia Canada
31 31
France Germany
28
Italy
32
Japan
21
U.K.
20
U.S.A.





In target-retirement-year funds
– Vanguard
– T. Rowe Price
– Fidelity
In proportion to countries’ market weights
In proportion to countries’ GDP weights
– 1980 – 2005
“Optimal” portfolio on the efficient frontier

 40-year career
 Predetermined portfolio allocation
–
–
Fixed asset allocation
Life-cycle asset allocation
 Take account of fund management costs


Conversion to single-life annuity at age 62
– Long government bond rate determines annuity price
Worker’s goal: Highest possible replacement rate

100% Allocation to U.S. assets
(1872-2005 returns)
Pension replacement rate (% of final pay)
160%
140%
120%
100%
80%
60%
40%
20%
0%
1910
100% US stocks
50% stocks / 50% bonds
100% US bonds
1920 1930 1940 1950 1960
Year pension begins
1970 1980 1990 2000
All stocks
All bonds

Vanguard life-cycle portfolio (based on 1927-2005 returns)
Pension replacement rate
(% of final earnings)
160
140
120
100
80
60
40
20
0
0
100% US Stock
Vanguard target-year portfolio
50% US Stock / 50% US Bond
25 50
Percentile
75 100
100% US stocks
Vanguard life-cycle
100% US bonds

Vary percent of equities allocated to foreign stock
Pension replacement rate
350
300
250
200
150
100
50
0
50
Allocation of portfolio across foreign and domestic assets:
100% Foreign
50% U.S. / 50% Foreign
100% U.S.
55 60 65 70 75
Percentile
80 85
Pension results in good years
90 95 100
100% foreign stocks
50% for. /
50% US
100% US stocks

Vary percent of equities allocated to foreign stock
Pension replacement rate
100
80
60
40
20
0
0
Allocation of portfolio across foreign and domestic assets:
100% Foreign
50% U.S. / 50% Foreign
100% U.S.
5 10
100% foreign stocks
15 20 25
Percentile
30 35
Pension results in bad years
40 45 50
50% for. /
50% US
100% US stocks

Conservative and aggressive “efficient” portfolios
Pension replacement rate
160
140
120
100
80
60
40
20
0
0
Aggressive int’l portfolio ___
100% US stocks ___
Conservative int’l portfolio ____
10 20 30 40 50
Percentile
60 70 80 90
60
100
0
40
20
160
140
120
100
80





In theory: International should help
Compared to 100% US stock portfolio –
–
–
–
Life-cycle fund reduces average pensions
Increases risk of low pensions
Result due to high allocation to bonds
Naïve international diversification –
–
–
Improves average and best pensions
Increases risk of very low pensions
“Efficient” international portfolios can –
–
–
Increase median and top-end pensions
Without harming pensions in worst years