01-04-2012, 08:18 AM
The Straits Times
Apr 1, 2012
Don't count fully on retirement calculators
Figures churned out depend on projected rate of return - and that's a big unknown
By Chris Taylor
Don't look now, but your retirement savings plan may not be as ironclad as you think. It may even include some magical thinking.
That's because every retirement calculator features an 'annual rate of return' that savers typically are asked to plug in for themselves. But no one really knows how well their investments will perform in the future - and that makes all our detailed retirement calculations seem kind of futile.
But here's something we do know: The good old days, when savers blithely counted on their retirement savings growing 7 per cent or 8 per cent or even 10 per cent, year after year after year, are likely gone. In the New Normal, cautious investors are learning to revise their expectations downwards.
People like Mr Louis Berlin, for example. The Miami insurance salesman was one of those who piled into risky assets in the late 1990s, and thought he could rely on hefty annual stock gains.
After losing hundreds of thousands of dollars in the dot.com bust, he settled on a new rate of return for the future: 3 per cent. Or, when he's feeling a little devil- may-care, 4 per cent.
'People get carried away on the high side, and when reality hits they're unprepared.' says the 58-year-old, who now keeps about half of his portfolio in equities.
A couple of basic building blocks: According to Irvine, 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 per cent annually, while long-term government bonds average 5.73 per cent.
That's a good place to start, and then you can start refining from there, depending on your particular asset allocation.
Just remember that whatever figure you jot down will have an enormous effect on determining how much you need to save right now.
'Very few people get it right,' says Ms Elle Kaplan, a financial adviser and founding partner of New York City's Lexion Capital Management.
'The assumptions you make are critical to your long-term financial health, and what I fear is that people are making inaccurate assumptions. They're too rosy, and by the time retirement comes around there's not too much you can do about it.'
Even among financial professionals, there's a wide range of expected rates of return. For its sample pre-retirement balanced portfolios, Baltimore fund shop T. Rowe Price plugs in 7 per cent annual returns, pre-retirement.
In a recent research paper titled How Much To Save For A Secure Retirement, Boston College's Centre for Retirement Research analysts used a slim 4 per cent. That might be overdoing it on the cautious side - but if being ultra-conservative prompts you to save even more, then that's not a bad outcome.
Better to end up with too much than too little.
There are some guiding principles that can help you arrive at your own answer.
Here are some tips for determining a projected rate of return that could work for you:
• 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 reversion to the mean and that your returns will be close to those numbers provided by IFA - almost 10 per cent for equities and a little over half that for long-term bonds.
• Estimate on the low side. That's because it's not realistic to expect to benefit fully from the rise of various asset classes. As behavioural economists will tell you, investors - guided by our emotions - tend to buy high and sell low.
• Use subtraction as well as addition. If your projected rate of return leads to a retirement total of a million bucks, say, it's not as if you'll end up with a million bucks in today's dollars to play with. There are a couple of portfolio-killers that eat away at that sum: Inflation and taxes.
Budget conservatively with your expected rate of return, and you'll end up like Mr Louis Berlin - confident, but not cocky about your assets as you head into your retirement years. After all, once you get there, you're still likely to have a couple of decades of projecting to do.
Reuters
Apr 1, 2012
Don't count fully on retirement calculators
Figures churned out depend on projected rate of return - and that's a big unknown
By Chris Taylor
Don't look now, but your retirement savings plan may not be as ironclad as you think. It may even include some magical thinking.
That's because every retirement calculator features an 'annual rate of return' that savers typically are asked to plug in for themselves. But no one really knows how well their investments will perform in the future - and that makes all our detailed retirement calculations seem kind of futile.
But here's something we do know: The good old days, when savers blithely counted on their retirement savings growing 7 per cent or 8 per cent or even 10 per cent, year after year after year, are likely gone. In the New Normal, cautious investors are learning to revise their expectations downwards.
People like Mr Louis Berlin, for example. The Miami insurance salesman was one of those who piled into risky assets in the late 1990s, and thought he could rely on hefty annual stock gains.
After losing hundreds of thousands of dollars in the dot.com bust, he settled on a new rate of return for the future: 3 per cent. Or, when he's feeling a little devil- may-care, 4 per cent.
'People get carried away on the high side, and when reality hits they're unprepared.' says the 58-year-old, who now keeps about half of his portfolio in equities.
A couple of basic building blocks: According to Irvine, 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 per cent annually, while long-term government bonds average 5.73 per cent.
That's a good place to start, and then you can start refining from there, depending on your particular asset allocation.
Just remember that whatever figure you jot down will have an enormous effect on determining how much you need to save right now.
'Very few people get it right,' says Ms Elle Kaplan, a financial adviser and founding partner of New York City's Lexion Capital Management.
'The assumptions you make are critical to your long-term financial health, and what I fear is that people are making inaccurate assumptions. They're too rosy, and by the time retirement comes around there's not too much you can do about it.'
Even among financial professionals, there's a wide range of expected rates of return. For its sample pre-retirement balanced portfolios, Baltimore fund shop T. Rowe Price plugs in 7 per cent annual returns, pre-retirement.
In a recent research paper titled How Much To Save For A Secure Retirement, Boston College's Centre for Retirement Research analysts used a slim 4 per cent. That might be overdoing it on the cautious side - but if being ultra-conservative prompts you to save even more, then that's not a bad outcome.
Better to end up with too much than too little.
There are some guiding principles that can help you arrive at your own answer.
Here are some tips for determining a projected rate of return that could work for you:
• 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 reversion to the mean and that your returns will be close to those numbers provided by IFA - almost 10 per cent for equities and a little over half that for long-term bonds.
• Estimate on the low side. That's because it's not realistic to expect to benefit fully from the rise of various asset classes. As behavioural economists will tell you, investors - guided by our emotions - tend to buy high and sell low.
• Use subtraction as well as addition. If your projected rate of return leads to a retirement total of a million bucks, say, it's not as if you'll end up with a million bucks in today's dollars to play with. There are a couple of portfolio-killers that eat away at that sum: Inflation and taxes.
Budget conservatively with your expected rate of return, and you'll end up like Mr Louis Berlin - confident, but not cocky about your assets as you head into your retirement years. After all, once you get there, you're still likely to have a couple of decades of projecting to do.
Reuters