Subscribe to this BlogAre your retirement assumptions realistic?
In its most recent survey of corporate pension accounting, Hewitt reports that the average assumed long-term rate of return at year-end 2008 is 7.98%. That’s the number that companies estimate they'll earn annually on their pension investments; they use that guess to help decide how much they must invest today to pay future benefits. While 7.98% is lower than the 8.34% assumed rate in 2004, it still seems a tad optimistic when viewed through “new normal” binoculars. Stocks aren’t expected to earn much more than 8%, and there’s little reason to expect bonds will post returns beyond their 5% historical long-term average. (In fact, given where we are in the interest rate cycle, 5% might be optimistic.)
Even before the credit crisis fallout, there was plenty of skepticism about corporate pension assumptions. In the 2007 Berkshire Hathaway shareholder letter Warren Buffett stepped through yet another of his clear-eyed market/math lessons that pointed out the long-term trend is for stocks (net of expenses) to earn around 7% and bonds 5%. Plug that into a 70/30 stock-bond mix (typical for pension funds) and you get a return closer to 6.5% than 8%.
I am going to leave the world of pension funding/underfunding and switch gears to what matters more for many of us: The rate of assumption we have for our self-managed 401(k) and IRA retirement assets. After all, most of us aren’t covered by traditional pensions. And that leads me to ask the question: What’s your assumed rate of return? (See the poll below.)
Beware of the “garbage in, garbage out” trap. The higher the rate you use, the higher the risk you run of falling short. First off, there's the problem of high expectations falling short of real-world returns. Second, when you assume a high rate of return it often becomes an excuse to contribute less. And to be sure, after the 18% annualized gain for the S&P 500 in the 1990s it was easy to assume the markets would do most of the heavy lifting for our retirement.
Consider how different rates of return would impact a $250,000 retirement portfolio today. (Assume no additional contributions.)
In 15 years, the $250,000 would be worth:
• $2.99 million @ 18% assumed rate.
• $1.04 million @ 10% assumed rate
• $793,000 @ 8% assumed rate
• $643,000 @ 6.5% assumed rate
So, what rate are you banking on? To see the impact of different assumptions, check out this calculator where you can adjust your contributions and assumed rate of return. And keep in mind the advice of Steve Utkus, chief of Vanguard’s Center for Retirement Research: “Contributions need to be higher than many of us imagined. Markets, averaged out over good and bad periods, are now recognized to play a smaller role.” Are you ready to pony up more?
The flaw in this analysis is to go after zero risk in retirement. There is always risk of one type or another.
To assume no return (or very low), it quickly becomes impracticle and people give up.
18% long term is the opposite end of the spectrum. It is an insane value. This causes people to invest too little.
Pick a reasonable value (say 8-10%) and invest based on that. It is a reasonable assumption and the amount you need to invest is reasonable. If you come in a little low an extra year or two can make up the difference.
Even at the lower 6.5% example you 2/3 of million to work with. Not extravagent, but you if you watch you spending you can get by on it.
My adult son, who is profoundly retarded, was notified that he has been pre-approved for a Platinum Visa credit card. He cannot read or write. This seems to be a metaphor for what went wrong with our financial situation.
Retired last year at 63 and living a very comfortable life with just a 401(k) and IRA. For some reason – luck or smarts – I moved most of my investments from equities to CDs (some of which paid over 6%) about 2 years ago and ended up losing very little money. Because CD rates are way down, I'm now investing in bonds and notes, and doing just fine on my monthly income on investments. Have also bought some stocks in the last few months. I actually make more every month than I need and LIFE IS GOOD.
When my daughter was 15, I started her an IRA with $1500 and we put it in a well known mutual fund account. She is now 30 and it is worth $1200. I think I would not count on making any money if one uses mutual funds or stocks unless they use timing and trade and are lucky. Put your money in fixed rate investments such as CDs.
I guess I am one of the fortunate ones out here. I just retired in November at 55 and have a pension that equates to 70% of my salary. I have another pension that kicks in at 60 that will brings me up to 90% and with the house paid off life is good.
It must be nice to have something to retire on. I'm 57. My salary has been cut by 10%, my bonus was cut out, my employer stopped contributing to my 401k and I had to cash out my IRA to save my home. I’m just happy to have a job.
I'm betting on a rebound (from CURRENT values), but 18% year-over-year is nonsense. As is 10%.
The solution is to PUT MORE IN.
I am banking on a zero rate of return and working until the day I die. I think we can all safely assume retirement is another idea who's time has past.
The financial advisors and column writers all say just to pony up more. Well in reality that just isn't possible in many situations especially when income is cut and expenses continue to rise. Also with retirement savings and investments taking losses it isn't reasonable or practical. So what's the answer?
It was a -major hassle- with my wife's new employer to set our desired 401k withholding. They just -assumed- and automatically signed her up for 6% (the amount the company matched.) What they should have done during her HR in-processing was provide a form for her to adjust this (upwards, in our case.) Instead, in a game of point-the-finger, the HR people referred her to the 401k vendor, and back-and-forth while accounts & PIN numbers were established, etc. -A Month- later, we were able to set the 401k amount to what we wanted (basically maxed out).
It should NOT be this hard!
I plan to retire, put all assets in trust for my children and then: I'm not going to worry about it!
Such "new normals" have been consistently "sold" to investors for the past decade. A few years ago, it came down to 8% from @10%. Now we are being asked to adjust to 7%-8% AFTER a crash of 40%.
My view is that there is no need to give money to people (in the form of bonds or stocks) if they have no clue. Rather keep the money to yourself, enjoy your life and invest in yourself (education, business, your friends, etc.). No need to waste your money with people who consistently ask you to lower the bar.
I can't pony up more and I'm not alone.
My bonuses have been cut, and I have 2 children in college, and their tuitions are not going down. I'm worried that I or my spouse could be laid off before I'm ready to retire and might need a bigger cushion for that.
I'm 63, still working. We paid for 4 weddings, 4 college educations. There was no money for retirement savings. I did a 5yr stint with GE and reinvested the pension money on exiting, into GE stock in 1982. That was my retirement pot. Looked like a good strategy til 2009. Good thing my wife had a pension plan at work. No choice but to stay in the market in retirement, otherwise inflation will eat up the value of our portfolio.