Recommended Reading: PIMCO on Diversified Portfolios for Retirement Investing

by: Brad Case

PIMCO, the company that I think has been perhaps the most thoughtful about investment approaches in the current market environment, has come out with a new report that should be on every investor's reading list. The report is called "Designing Outcome-Oriented Defined Contribution Plans (DC 2.0): Maximizing Absolute and Risk-Adjusted Returns for a New Normal Economy," and although it's directed toward providers of 401(k) and other DC plans, it really would be valuable reading for any investor or investment advisor, including individual investors and even managers of pension plans and other defined benefit (DB) portfolios.

The stars at PIMCO include its two co-CIOs, founder Bill Gross and CEO Mohamed El-Erian; Gross is the one who coined the term "The New Normal" to describe what they think is a long-term investment environment of relatively low returns with relatively high volatility--exactly the kind of environment in which holding a diversified portfolio is most critical. Coincidentally, Forbes has an excellent new article focusing on Gross, El-Erian, and PIMCO's current investment advice.

The new report was written not by Gross or El-Erian but by another PIMCO thought leader, Stacy Schaus, who leads the company's Defined Contribution Plan practice and has authored several other thoughtful papers. (Ying Gao and Joseph Simonian are the other authors.)

Perhaps the most important part of the report is where PIMCO warns against both conservative portfolios (e.g., stable value only or TIPS only) and inadequately diversified stock/bond portfolios, showing how risky both type of approaches are. The report pays specific attention to the measures of risk that are important in managing a retirement portfolio, including the likelihood of failing to meet the required retirement income target.

PIMCO recommends a fully diversified investment portfolio, with asset class allocations changing as the investor gets closer to retirement. For an investor starting 40 years before retirement, PIMCO's "diversified glide path asset allocation" looks like this:

  • Large cap stocks (S&P 500 index): 15% during first 20 years, 12.5% during years 21-25, 10% during years 26-30, 7.5% during years 31-35, and 5% during the last five years before retirement.
  • Small cap stocks (Russell 2000 index): 15% (years 1-20), 12.5% (years 21-25), 7.5% (years 26-30), 5% (years 31-35), and 2.5% (years 36-40).
  • International stocks (MSCI EAFE index): same as large cap stocks.
  • Emerging market stocks (MSCI Emerging Markets index): 10% (years 1-20), 7.5% (21-30), 5% (31-35), 2.5% (36-40).
  • Publicly traded REITs (Dow Jones Select REIT index): 15% (years 1-10), 12.5% (11-20), 10% (21-25), 7.5% (26-30), 5% (31-35), 2.5% (36-40).
  • Commodities (Dow Jones UBS Commodities index): same as REITs.
  • Fixed income (Barclays Capital U.S. Aggregate Bond index): 2.5% (years 1-10), 5% (11-20), 15% (21-25), 25% (26-30), 30% (31-35), 35% (36-40).
  • TIPS (BC U.S. TIPS index): same as fixed income.
  • Long-term Treasuries (BC Long-Term Treasury index): 5% (years 1-20), 2.5% (21-25), none (26-40).
  • Long-term TIPS (BC U.S. TIPS 10-year+ index): same as long-term Treasuries.
  • Cash (Citigroup 3-month Treasury index): 0% (years 1-30), 5% (31-35), 10% (36-40).

The PIMCO report also looks at holding the diversified glide path but adding instruments such as long-dated equity puts, put spreads, and collars to hedge against bad-tail risk. I especially recommend looking at Figures 16 and 17.

Disclosure: I am long Vanguard REIT Index Fund and ING Global Real Estate Fund.

Disclaimer: The opinions expressed in this post are my own and do not necessarily reflect those of the National Association of Real Estate Investment Trusts ((NAREIT)). Neither I nor NAREIT are acting as an investment advisor, investment fiduciary, broker, dealer or other market participant, nor is any offer or solicitation to buy or sell any security investment being made. This information is solely educational in nature and not intended to serve as the primary basis for any investment decision.