Growing up, my parents called me “Big Bear” - Mom nor Dad never admitted to this but I think the name stuck because I grew horizontally before I grew vertically. My Dad would say “Big Bear - never lie to your mother or myself. I have a high propensity for the truth.” I wasn’t exactly sure what the word “propensity” meant in elementary school, but I understood it was very important to tell the truth.
As you might imagine, Dad’s zeal for the truth has carried over into his career and our practice. I have heard him tell clients numerous times… “I’m going to tell the truth even when it is uncomfortable. That is why you hired us.” And he has.
Investment return assumptions are something that investors do not always want to hear the truth about. They sometimes want to believe that the market will continue to grow at an above average rate of return. Some investors have developed unrealistic expectations for returns for many different reasons. Whether they heard it from a financial advisor “encouraging” them to retire early, talked to a friend, read some prediction online or stumbled across a “rule of thumb” that they thought they could trust.
Stock Market Returns
Let’s take a quick quiz. On average, what can we expect stocks to return (dividends plus appreciation) over the next 10 years?
- 5%
- 7%
- 9%
- 11%
The answer is E. We do NOT know. Historically, the stock market has averaged approximately 8%1 over a long period of time but there have been decades of lower returns and actually one decade (i.e. 2000 – 2009) where stocks did not achieve a positive rate of return. With that being said, we think it is prudent advice to use conservative rates of return when making long-term retirement projections.
We have seen many financial advisors take a historical 8% annual rate of return and extrapolate it out for a few decades. By doing this, it can paint a “rosy” picture of retirement cash-flow projections.
This is very dangerous. If you have unrealistic return assumptions for your portfolio, you may potentially:
- Retire sooner than you should and possibly run out of money.
- Spend more than you should in retirement and possibly run out of money.
- Drastically reduce your standard of living in retirement after a market pull-back.
- Be anxious about spending and personal finances and dramatically reduce the quality of your retirement.
What Return Assumptions Should Investors Use?
This is a complex discussion and warrants analysis and discussion. The answer depends on financial goals, stock vs. bond allocation, composition of your portfolio, income needs, and a number of other important factors. Most of our clients need to withdraw between 2% - 5% annually from their retirement portfolio to meet their income needs.
The Price Group has developed an objective process to simplify the conversation surrounding long-term return assumptions. We call it the Family Index Number – the rate of return your family needs to have a “successful” retirement. Or the rate of return your family needs to retire by a certain age.
Your Family Index Number is the estimated rate of return from your investment portfolio required to achieve your goals and objectives with confidence. Our goal is to achieve the client’s Family Index Number over a market cycle. In some years, we will outperform this goal and some years we will underperform.
How Do I Determine My Own Family Index Number?
You need a long-term holistic wealth to act as your retirement roadmap. We create a Live Well Plan for clients (and prospective clients) because our primary goal is to have our clients live well.
Creating a Live Well Plan ultimately helps you answer two questions:
- Do I have enough to retire?
- How long will my money last?
Our Live Well Plan encompasses and coordinates all areas of your personal finances. This plan includes cash-flow projections and allows us to test adjustments made in real time and predict your retirement readiness striving to ensure that you are in the “green zone.”
Ultimately, you need to have someone take a holistic look at your personal finances to determine your Family Index Number.
Conclusion
“Garbage in – garbage out” is the best word illustration to explain this topic. What type of assumptions have been made to construct your plan? Are the assumptions personalized and specific to your family or are you invested in a “cookie cutter” fashion? Are the assumptions too optimistic? What degree of confidence do you have this plan will work?
The best time to create a Live Well Plan is 4 – 6 years from retirement. This is because you still have some “runway” left to implement any potential changes that could be needed.
Want to create your own Family Index Number and Live Well Plan? Give us a call.
The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of the author and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions. Keep in mind that there is no assurance that any strategy will ultimately be successful or profitable nor protect against a loss.