Why The Experts Think Your Retirement Plan is Broken

Your retirement plan is broken - experts

Big investment research houses on Wall Street, supported by professional research houses worldwide, are predicting sub-par investment returns over the next 10 years. Here’s what that could mean for your retirement plans.

Background: Why Returns Matter

Financial markets have been good to investors for the past decade or more. In the ten years ending on 31 December 2021, the S&P 500 (the most common measure of the world’s largest stock market) returned an impressive 16% annual return. But today, the consensus of expert opinion is to expect returns over the next few years to be lower than we’ve been used to. Of course, such forecasts can be way off the mark. But you need to assume some future return to estimate whether your investment mix will support the future life you want within the time frame you’ve allotted.

What Wall Street Is Saying

Wall Street is an eight-block-long street in the financial district of Manhattan, in New York City. The term "Wall Street" is now used as a term to encompass the financial markets of the United States as a whole – the largest financial market on earth, and the one which sets the standard for investing worldwide. So, when the financial powerhouses on Wall Street say something, the world pays attention.

Heavyweights including JP Morgan, Charles Schwab, Research Affiliates, Northern Trust Asset Management, Kiplinger, and Morningstar have all published 2022 forecasts predicting lower-than-typical asset returns for years to come. These have been supported by similar predications from local investment research houses and consultancies, including Mapua. Those research houses that have issued predictions in the last few months are listed below.

Morningstar, as at June 2022

• US equities: 5.8 percent

• Developed market equities: 8.8 percent

Research Affiliates, as at June 2022

• US equities: 6.3 percent

• Developed market equities: 11.8 percent

Blackrock, as at April 2022

• US equities: 7.1 percent

• Developed market equities: 8.3 percent (European equities only)

It's important to note the parameters for these return estimates vary; some of the return expectations are inflation-adjusted, while most are not (nominal). In addition, some of the experts forecast returns for the next decade, while others employ slightly shorter time horizons.

As you’d expect, firms will always vary in their approaches to formulating forecasts, though most rely on some combination of current valuations, current yields, expected earnings growth, and inflation expectations. Finally, it's worth noting that the market is always moving – always reacting to the most up to date information – so expect any forecast to be fluid, too.

Even noting firms differ in their methodologies, the specifics of their outlooks, and even the time frames covered by their forecasts, every firm expects that U.S. equity returns over the next seven to 10 years will be well below the 16% annualised return the S&P 500 has posted over the past decade.

If It’s That Hard to Plan, Why Bother?

It might be tempting to write off all forecasting as a waste of time and effort.

While it's almost impossible to guess the market's direction on a short-term basis, return expectations can be useful – and are arguably even mission-critical – when setting up your financial plan. After all, you need to plug in some type of long-term return assumption when deciding whether your savings rate, time horizon, and what you want to achieve all match up. If you're already retired, being realistic about return expectations is also essential when determining a sustainable withdrawal rate.

What Can Investors Do to Adapt to Market Turmoil?

The research indicates that a conservative withdrawal approach, and conservative expectations of likely investment returns for all assets, is an important way to navigate an uncertain market environment, especially at the onset of retirement.

The Four Percent Rule

A widely accepted withdrawal rule for retirement portfolios is four percent. This partly comes from the FIRE movement (“Financial Independence, Retire Early”) is a financial movement defined by frugality and extreme savings and investment. Many retirees — especially those in the FIRE movement — base their retirement withdrawal plans on healthy investment returns.

FIRE was born out of the 1992 best-selling book Your Money or Your Life by Vicki Robin and Joe Dominguez. FIRE came to embody a core premise explained at length in the book: People should evaluate every expense in terms of the number of working hours that it took to pay for it. Then, by saving up to 70% of their annual income, FIRE proponents aim to retire early and live off small withdrawals from their accumulated funds. Typically, FIRE followers withdraw 3% to 4% of their savings annually to cover living expenses in retirement.

While analysis by some of the research houses listed earlier was mostly encouraging based on the lower anticipated returns in years to come – the four percent withdrawal guideline may be a reasonable rule of thumb for those who are years away from retirement. Though for investors closer to retirement, and already retired, there is a greater need to consider specific circumstances and retirement budget.

Based on what we here at Become Wealth know about actual spending patterns in retirement, on average, inflation‑adjusted spending declines by about two percent annually after age 65. This is consistent with international research.

Additionally, retirees usually adapt their non-discretionary spending to their level of ‘guaranteed’ income in retirement. So, understanding specific spending needs to determine which expenses are essential and which are discretionary can help retirees modify their withdrawal approach.

Use a Professional

The best bet when it comes to securing your future is to discuss it with a trusted financial adviser, such as those at Become Wealth (yes, that is a shameless plug!). Get in touch to book a complimentary initial consultation.

You can then compare the data above to other “predictions” that you’ve heard, and weigh them appropriately.

Take your time with investing decisions. One article shouldn’t change a decades’ long plan.

Keep Calm and Carry On

Those who already have a financial adviser to carefully consider their situation, dreams, and have taken practical action to analyse and construct a portfolio of investments to help achieve their dreams can probably sit back and stay the course. This might also apply to those who have developed and stress-tested their own financial plans.

Good financial planning will have already planned using lower-than anticipated returns, and over many years of steady investment may pleasantly surprise on the upside.

The Bottom Line: The Professionals Say Your Plan Is Broken

Long-term forecasts don’t necessarily have a long shelf life. They’re revised regularly as market conditions change, producing ripples of change in future returns. And you should beware of making apples-to-apples comparisons using forecasts from different sources, as the core data and assumptions that firms use to make forecasts can wildly vary.

With the obvious and increasing concerns both over inflation levels and probable investment returns, it’s important to leverage all available resources to help make the most of every dollar, and ensure you’re on track to achieve – or maintain – the life you deserve.

It’d be the pleasure of one of our trained professionals to help you work through your retirement plans, so get in touch today.

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