4/17/2014 8:30 PM ET|
Your retirement is in danger: Save it
Few financial issues are more important to us than planning for our golden years. Yet many people are at more serious risk of running out of money than they realize.
Invest $100,000 in a typical retirement account when you are 25, and how much should you expect to have when you collect your gold watch 40 years later
Based on some standard industry assumptions about investment portfolios, returns and volatility, a money manager might tell you that the "average" outcome would be in the region of $1.2 million, adjusted for inflation.
But here is the problem: That "average" masks a lot of trouble. Even if you use those same standard assumptions, more than half the time you will end up with less than $750,000. And a lot of the time you will end up with less than $350,000. Contrary to popular myth, the results aren't distributed normally, in a bell curve. Thanks to volatility, they are bunched at the low end.
From $1.2 million to $350,000 or less -- that is going to make quite a difference.
This mathematical analysis appears in "Investing for Retirement: The Defined Contribution Challenge," a new paper by Ben Inker and Martin Tarlie at GMO, a Boston-based investment firm with $117 billion under management.
It took me back to my high-school math, and the difference between the three types of average -- the mean, the median and the mode. To put it in a nutshell, that $1.2 million is the mean, or simple average, and it pretty much is useless for planning purposes.
Few financial issues are more important to us all than planning for our retirement. And yet our approach to the subject is riddled with some serious logical and mathematical errors, Inker and Tarlie argue.
We misunderstand averages, volatility and the likely distribution of returns, they say. And we may be misunderstanding financial history as well.
Many retirement planners, including the people from the 401k company hosting the free seminars at your workplace, derive their forecasts for future returns from the past. That is perfectly understandable, as far as it goes. But it is flawed.
Data from New York University's Stern School of Business show that since 1928, U.S. stocks, as measured by the S&P 500 ($INX) have earned average returns of 9.6 percent a year, while 10-year Treasury notes have earned 5 percent a year.
But today the 10-year Treasury sports a yield of just 2.8 percent. Good luck trying to squeeze 5 percent a year from a 2.8 percent bond, Inker notes. Meanwhile, the S&P 500 now trades at around 25 times cyclically adjusted per-share earnings of the past 10 years, a measure known as the Shiller price/earnings ratio, after Yale finance professor and Nobel laureate Robert Shiller.
Yet data tracked by Shiller going back to the 19th century has found that when the U.S. index has traded at these levels, subsequent returns have typically been dismal -- often failing even to keep up with inflation.
"This is a dangerous time to be close to retirement," said Inker, co-head of GMO's asset-allocation committee, when we met earlier this month in the firm's offices overlooking Boston Harbor. Because of elevated asset valuations, relying on standard planning may "leave you in serious trouble."
So what can we do about it?
Some of the authors' conclusions aren't controversial. Investors need to get a better understanding of the risks of poor returns. And they need to save more -- often much more -- to compensate.
Two of Inker and Tarlie's other conclusions may raise eyebrows. First, and counterintuitively, they say that many investors may need to take the plunge and invest more aggressively than conventional wisdom suggests. That means holding more stocks and fewer bonds. That is because, even though stocks are volatile and returns may be well below historic averages, over time they still tend to beat bonds by a wide margin. And many investors simply can't afford low returns.
Second, they argue that investors should hold more foreign stocks, as opposed to U.S. stocks.
GMO believes international stocks are a better value than those in the U.S. and offer better returns. But the argument stacks up even if you don't necessarily embrace that analysis. If we should diversify as much as possible to earn the best returns for the risk, shouldn't we invest globally as a matter of course? Why should we have most of our eggs in the S&P 500?
At a social gathering, I once met the head of "target date" retirement funds at a big investment company. I asked him why, across the industry, all such funds -- in which allocations grow more conservative over time -- were so overinvested in U.S. stocks at the expense of global diversification.
"Because that's what the clients want -- it's what we can sell," he confessed. It had nothing to do with what was actually likely to be best for the clients in the long run.
A spokesman at the Investment Company Institute, which represents the mutual-fund industry, noted that international stocks, including emerging markets, accounted for 30 percent of the equity allocation of the typical target-date fund. But this still is well below their share of the global stock-market indexes or global economic output.
It is hard to see why the default allocation shouldn't be to put one third of one's equity allocation in U.S. stocks, one third in developed overseas markets and one third in emerging markets -- even if you aren't taking a view about which is better value.
GMO has a reputation for taking a deeply cautious view on markets. But that doesn't undermine the analysis by Inker and Tarlie. And it leads to one other implication that they don't pursue but which I can't avoid raising. If investment returns from stocks and bonds look so meager today, it may be sensible to park more money on the sidelines in cash or an equivalent, such as a money-market or stable-value fund -- and wait, and hope, that stocks or bonds will get cheaper.
Is that "timing" the market? Yes. Is it "risky"? Yes.
But so is trusting the "averages."
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"Invest $100,000 in a typical retirement account when you are 25......Based on some standard industry assumptions...... be in the region of $1.2 million, adjusted for inflation."
This is more Pie in the Sky talk that just ignores the Realities that the next Generation of Retires will have to face. You Don't Rob Peter to pay Paul for Decades without paying a Major price. This Generation of retires got off easy, the case won't be the same for the next.
Let's review the basics. 1) Start early and invest regularly, as much as you can. 2) Understand your options. Use your 401K, and never turn down the employer match. Understand the options available to you in your 401K; the "default" to company stock or a single mutual fund (or worse a money market fund) is never the best option. 3) Diversify, review periodically, and rebalance when needed. 4) Never ever use retirement funds for anything other than a real emergency.
Asset growth, like income, is not equally distributed. You have to work at it.
When I was young my parents drummed into me the value of saving money, living within your means, staying out of debt, and having a rainy day fund. I learned and followed their lessons. I started working in my teens. I worked two full time jobs for a number of years, a full time and part time job, and I put myself through college.
I saved my money and stayed out of debt. I was a very conservative investor when I was young. I investment my money in savings and checking accounts, CD’s, government bonds, and money markets funds. In my twenties interest rates were higher than today and I made good income on my investments. When I was in my thirties I taught myself how to invest in the stock and bond markets.
I learned you can start small and grow your investments over time. I also learned the importance of dollar cost averaging and the magic of compounding. I took advantage of my company’s 401K plans and the matching programs they officered their employees. I tried to increase my contributions to my tax sheltered 401K and IRA account each year I worked. I diversified my investments and tweaked my investment allocation when needed.
I have been working for over forty years. I have been downsized a few times and had to start over again. I have lived through the ups and downs of the economy, the gas crisis, world changing news, and other earth shaking events. Throughout the years I kept to my investment and retirement strategy. I learned the importance of starting saving and investing early, staying out of debt, living within your means, and having a rainy day fund for those unexpected events.
As I grow closer to retirement age I am on track to achieve all my investment and retirement goals. My advice to anyone who wants to live comfortable when they retire is to start investing early, live within your means, stay out of debt, have a rainy day fund, and to have an investment and retirement plan. The sooner you start the easier it will be when you get older.
I say that the CBO has unrealistic expectations moving forward since how do you predict with any degree of accuracy where rates will rise as Globally Debt has Soard 40% since the Great Recession. A National Debt well over $30Trillon may well be in the Cards and that will flip around many of the Retirement expectations in investments and what type moving forward.
I find it laughable that folks can just put out projections for the Stock Market without any consideration to future Debt Loads and or issues due to the Money Stolen from the Social Security and Medicare Trust Funds. I find it even more laughable that so many Folks have totally disregarded the issue of the still looming problems of $500-700Trillion in Scam Banking Derivatives.
So go ahead, Disregard the $4Trillion plus Fed Balance sheet and the failure of so many Corporations to invest in Cap X and instead focus of just rewarding those in the top 1%. America has no Real Future of Retirement if we keep disregarding the working Poor and the fast Fading Middle-Class.
In addition from Social Security you will probably get $2,000 per month which means $24,000 per year which is equivalent of 4% per year of $600,000 or so. And that keeps growing with inflation. Also, if your private stash grows at 4% per year take out 7% per year. At that 3% difference your stash will last 33 years. At 60+33 = 93 who cares if your stash is all gone. The "Home" is going to take it all as well as your Social Security anyway.
As is typical of MSN when they post an article that they know will get blasted they don't open to comments. So, I am commenting here about the article titled, "Obamacare Hits 8 Million Sign Ups". In a way these articles are connected because retirement depends on investment and it is hard to invest when you have nothing left. So, I have the following questions:
1) What is the percentage of sign ups that are receiving subsidies?
2) What are the exact demographics? The article states 26% are between the ages of 18-35, but does not mention how many of them are receiving subsidies. Just last week there was an article about two people, 19 & 20, who are receiving subsidies.
3) How many have actually made any payments?
4) How many were previously uninsured and how many were canceled because Obama personally decided their coverage wasn't sufficient. Ex. Elderly women, women who have had a hysterectomy, any man who is now forced to have obstetric coverage.
5) What are the deductible and co-pays?
6) Considering some young people will receive subsidies instead of fund subsidies, how will the subsidies be funded? How many believe Obama, Biden, Reid, Pelosi or any of the other minions are going to write checks to cover it?
7) And finally where will people actually get medical CARE? There have been multiple articles over the last few weeks about medical facilities that will not accept coverage obtained through Obama exchanges. Including an article that stated only 4 that's FOUR cancer treatment centers in the country will accept it. So, how many miles will people need to travel for help and how many will be turned away?
And in case you need a reminder of how arrogant and ignorant Obama is, in the article he is praising how they beat the projection of 7 million sign ups but failed to mention the deadline(s) have passed?
To all true Americans, this November could very well be our last chance to save our country. We can't vote him out yet, but we can get rid of his mindless minions. Vote out every incumbent who supports our Socialist in Chief so we can at least hamper his continued attempts to destroy all we are and all we stand for.
I know helping those is need is important and I don't object to that. But I am tired of supporting those who's only affliction is entitlement syndrome.
If things don't change the well will soon run dry.
It is sad to read so many negative comments on a very prescient, logical column. It’s much easier to live on 4 years of welfare (cloaked as "unemployment insurance") and whine on the posts while you wait for urkel to steal it from one those who pursued one or more STEM degrees graduated in 3 years with a BS and and added two for a MS/MBA or JD and then worked and invested for 40 years. Good ol’ U.S.S.A.
1st. There's isn't a 25 year old in this country with 100 thousand dollars unless it was given to him by his rich family. As for the rest of the 25 year old they mite have 10 -20 thousand . And since the banks do not give you any interest on your money they will never have 100 k until they are well over 40.
and that's if they save a few thousand every year .
Get a clue editor......Dumb A$$
The premise of this article is beyond braindead, but let's run with some calculations based on its figures.
If you open with $100,000 an account for a 40-year series of compounded (quarterly) returns, the following annual percentage returns (APRs) are needed for the stated values at the maturity of the account:
$350,000 maturity . . . 3.144% APR
$750,000 maturity . . . 5.069% APR
$1,200,000 maturity . . . 6.260% APR
Whether it's post-2008 mutual funds or Treasurys, it's unlikely any prudent scenario (i.e. no substantial risk of loss of principal) will produce much more than perhaps $450,000 (3.777% apr) --without benefit of a Dylanesque "Simple Twist of Fate."
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