1. 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

2. Can retirement savers benefit from cross-national diversification? 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

3. Source of concern: Excess sensitivity of pension to late-career returns Geometric mean return over career = 7%. In exactly one year during career: Return = -50%. In other 39 years: Return = 9.1%. 5.6% 114% 53% 9%

4. Source of concern: Persistence of bad returns Stock returns … although not in these 3 countries

5. Source of concern: Persistence of bad returns Stock returns

6. Source of concern: Persistence of bad returns -10.2% -2.9% Japan: Stock returns … big time

7. Another source of concern: High variability of overseas returns

8. International investing: Portfolio allocation / country weights 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

9. Assumptions 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

10. Results: 100% Allocation to U.S. assets (1872-2005 returns) All stocks All bonds

11. Results: Vanguard life-cycle portfolio (based on 1927-2005 returns) Vanguard life-cycle 100% US stocks 100% US bonds

12. Results: The good news Vary percent of equities allocated to foreign stock 50% for. / 50% US 100% foreign stocks 100% US stocks Pension results in good years

13. Results: The bad news Vary percent of equities allocated to foreign stock 50% for. / 50% US 100% foreign stocks 100% US stocks Pension results in bad years

14. Results: Conservative and aggressive “efficient” portfolios Aggressive int’l portfolio ___ 100% US stocks ___ Conservative int’l portfolio ____

15. Conclusions 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