When it comes to retirement income planning, one of the most important decisions you’ll make is the assumption for your projected rate of return.
Before the market crash of 2008, counting on your retirement savings growing 8, 9 or even 12 percent plus, year after year after year, are likely gone. In the ‘new normal’, cautious investors are learning to revise their expectations downward and for good reason. Recent market volatility, the debt crisis in Europe, a slower growing global economy, a weak real estate market and political gridlock have all contributed to revisiting long-term growth forecasts.
Setting Realistic Investment Returns
What is realistic when it comes to setting your projected annual return amount?
According to California-based Index Fund Advisors (IFA), 86 years of data reveals the long-term return of the Standard & Poor’s 500 index to be 9.78 percent annually, while long-term government bonds average 5.73 percent. Use these historical figures as a starting point and start refining from there depending on your particular asset allocation.
Keep in mind that whatever figure you decide on will have an enormous effect on determining how much you need to save right now in order to reach your goal of retirement in year x.
The assumptions you make regarding your investment returns are crucial to your long-term financial wellness. If your forecast is too optimistic, by the time retirement rolls around there’s not much you can do about it, which is why this assumption has to be thought through with the care and seriousness it deserves.
Mutual fund giant Vanguard uses 6 percent for a long-term, balanced portfolio rate of return for their retirement calculator whereas T.Rowe Price, another large mutual fund company, uses 7 percent annual returns.
Of course, being ultra-conservative with these key assumptions will mean you need to save more, actually quite a bit more each year than if you were to use say 7 percent or 9 percent. But like my wife Pat who often reminds me it’s better to show up early rather than late to a meeting, better to end up with too much than too little.
Retirement Planning Tips:
As easy as it seems to plug a few numbers into a web retirement calculator and poof-out comes a retirement plan, please think again, it’s not as simple as it appears. As an attorney once told me before I was about to represent myself in court for a speeding ticket; “Only a fool has himself for a client”.
Here are some helpful tips for projecting a rate of return:
- Use long-term averages as a guide, not an absolute. If your time horizon until retirement is lengthy, with decades to go, then it's reasonable to expect a higher return over the long run. The shorter your time horizon, the less helpful those figures are as a guide.
- Go low with your estimates. I prefer using 6-7 percent as a modest guide for annual portfolio returns. And for clients that want to reach the finish line with plenty of room for comfort, I’ll often choose 4-5% annual portfolio returns. And remember, the biggest issue is not picking the ‘right’ investments or asset classes, its investors, guided by their emotions that too often tend to buy high and sell low. The issue is not necessarily too high or too low a return rate we choose but instead our money behavior and how we seem to move in and out of various investments at all the wrong times.
- Remember two crucial factors in terms of retirement planning. Number one-the money in your tax deferred retirement accounts is not 100% yours. A big chunk belongs to the IRS, perhaps 30-40 percent in some cases. Second, remember how corrosive inflation is to retirement income planning so plan for higher inflation. With the money the Fed has been printing, perhaps much higher inflation than the usual 3-4% projection most often used.
- Play it smart and conservative with your projected investment return, understand your relationship with money and the emotional triggers that can set you off and always check your progress at least yearly.
Photo credit http://www.flickr.com/photos/plaisanter/