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do we really get the compounding effect we think? dr pfau says no.
Old 02-27-2013, 04:17 AM   #1
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do we really get the compounding effect we think? dr pfau says no.

one of the issues we don't think about is that the returns we think we get and the money we should have by retirement is always looked at as pre-inflation.
it looks great when you look at these growth charts and see you will have over a million at retirement but if that is decades from now it is a different ball game.

throw in cagr average return values and when markets are down 50% and need to double to get back to where they are the compounded average returns work differently .
dr pfau ran some numbers looking at what we thought our compounding was vs what we really see.

dr pfau ran some numbers looking at what we thought our compounding was vs what we really see. in fact dr pfau found that 1.3 million dollars on the graph in todays dollars and with real world mathamatical forces may be 300k or so when saving 5k a year for 40 years at 8% average returns

very interesting paper as usual from dr pfau.

Retirement Researcher Blog: Compound Interest and Wealth Accumulation: It's Not As Easy as You Think
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Old 02-27-2013, 04:48 AM   #2
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The miraculous return with gains compounded is truly a mirage and over optimism. Looking back at how a supposedly hot fund company had done for my investments over 25 years: they returned a total of 71% on investment. Pfau is right, the rate I should use was only a little over 2 % a year compounded. Never mind the rosy forecast of doubling your money every 9 years on a 8% historical return used by many calculators.
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Old 02-27-2013, 04:53 AM   #3
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i always amazes me how all the things we take as the truth never seem to really be that way once the likes of dr pfau or michael kitces take it apart and look at it from another view.

look how 100% equities turned out to be historically be the safest bet we could all have made. safe cash instruments were the worst.

that flys right in the face of what we are led to believe is true.

i wonder if we were taught that the older you get the more you move into broad market investments with higher and higher allocations until we are spending down from 100% if that would have been the norm for us.
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Old 02-27-2013, 06:10 PM   #4
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A lot of luck is involved. My peak earning and investing years were 97 thru 05. That bad timing killed my overall returns. Probably in the 2% range after taxes when looking at the entire securities portfolio. Real estate was good to me but I've grown gray with all the volatility.
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Old 02-27-2013, 06:13 PM   #5
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Say this to all those who sold everything in a panic in 2008/2009. :-)
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look how 100% equities turned out to be historically be the safest bet we could all have made. safe cash instruments were the worst.
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Old 02-27-2013, 06:41 PM   #6
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Say this to all those who sold everything in a panic in 2008/2009. :-)
Using that logic you could also gloat about anyone who died before retiring.
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Old 02-27-2013, 06:52 PM   #7
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I put all my money in a company called Select Comfort 3 years ago. It has had an average annual return of 437% for the past 3 years. They sell water beds, so it was pretty obvious that the stock was primed to take off. I'll let you know my final returns later when I sell/sold/short it.
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Old 02-27-2013, 09:24 PM   #8
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one of the many ways to lie with statistics
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Old 02-27-2013, 09:37 PM   #9
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I don't believe in hysterical statistics.
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Old 02-28-2013, 03:21 AM   #10
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Say this to all those who sold everything in a panic in 2008/2009. :-)
whether they had the stomach or not does not chang the facts as they are to date.
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Old 02-28-2013, 10:40 AM   #11
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It is also posted here:

Debunking the myth of the 8% return - MarketWatch

He discusses the assumed 8% return on investments and the validity of it. The thing that I thought was interesting was this:


Quote:
Quote:
Personally, I use a 2% compounded and inflation-adjusted return assumption in my own planning spreadsheet, and I realize that this might even be a bit high.
.
It is more conservative than my assumption of 3.5%
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Old 02-28-2013, 10:54 AM   #12
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Interesting. I always thought that the 8%/yr average over long periods of time was including an inflation number, meaning REAL returns (in todays dollars) was more like 4%.

If 8% is the real return, my conservative-to-optimistic range of 2-4% seems silly.
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Old 02-28-2013, 12:18 PM   #13
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Originally Posted by mathjak107 View Post
one of the issues we don't think about is that the returns we think we get and the money we should have by retirement is always looked at as pre-inflation.
it looks great when you look at these growth charts and see you will have over a million at retirement but if that is decades from now it is a different ball game.

throw in cagr average return values and when markets are down 50% and need to double to get back to where they are the compounded average returns work differently .
dr pfau ran some numbers looking at what we thought our compounding was vs what we really see.

dr pfau ran some numbers looking at what we thought our compounding was vs what we really see. in fact dr pfau found that 1.3 million dollars on the graph in todays dollars and with real world mathamatical forces may be 300k or so when saving 5k a year for 40 years at 8% average returns

very interesting paper as usual from dr pfau.

Retirement Researcher Blog: Compound Interest and Wealth Accumulation: It's Not As Easy as You Think
Dr. pfau,
This is the guy who thinks immediate annuities are the way to improve your retirement withdraw rates. NOT a fan of this guy -- sorry to all his followers, just my opinion.

I have calculated my return rates over 30 years, and I find the Excel GEOMEAN formula just fine to do so.

Of course we have to be mindful of inflation, but IMHO, it is not necessary to track your CAGR in an inflation adjusted manner. How you want to track your investments is in an unadjusted manner, which makes it easier to see at a glance whether you are doing better or worse than the market indexes. What MOST people need to be worried about is the fact that they can NOT even keep up with the market index, due both to the "churn" they inflict on their accounts and the active type funds or stocks they invest in, or alternately the conservative asset allocation they choose -- these are the "killers" to their account.

fd
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Old 02-28-2013, 01:20 PM   #14
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Just a question-perhaps off topic but related.


when social security gives you projection of benefits based on when you retire-is inflation a factor.

just wondering
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Old 02-28-2013, 01:22 PM   #15
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Quote:
Originally Posted by gsparks2 View Post
It is also posted here:

Debunking the myth of the 8% return - MarketWatch

He discusses the assumed 8% return on investments and the validity of it. The thing that I thought was interesting was this:


Quote:
.
It is more conservative than my assumption of 3.5%

i use the calculator at msn money. i use 3 percent inflation and 2 percent return on investment-just to play safe
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Old 02-28-2013, 01:43 PM   #16
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Originally Posted by bo_knows View Post
Interesting. I always thought that the 8%/yr average over long periods of time was including an inflation number, meaning REAL returns (in todays dollars) was more like 4%.

If 8% is the real return, my conservative-to-optimistic range of 2-4% seems silly.
That's been my experience. At the time, safe Treasuries were providing an inflation adjusted 2-3%, so if you took on more risk, you used the 4% as the real rate.
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Old 02-28-2013, 03:06 PM   #17
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Just a question-perhaps off topic but related.


when social security gives you projection of benefits based on when you retire-is inflation a factor.

just wondering
My understanding is that the numbers they quote you are in today's dollars so the absolute amount you receive when you retire will be adjusted upwards for any COLA increases between now and when you retire.
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Old 02-28-2013, 03:30 PM   #18
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My understanding is that the numbers they quote you are in today's dollars so the absolute amount you receive when you retire will be adjusted upwards for any COLA increases between now and when you retire.
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Old 02-28-2013, 10:32 PM   #19
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My understanding is that the numbers they quote you are in today's dollars so the absolute amount you receive when you retire will be adjusted upwards for any COLA increases between now and when you retire.
You can read more about their estimator on the actual SS website:

Retirement Estimator

Another way to say this is they only make the project based on your current salary and the current law, they do not inflate anything, nor assume you get any raises on the way. They also do not know what their index adjustment factor is going to be until you actually sign up for the benefit and they have current data -- that's why they call it an estimate.

fd
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Old 03-01-2013, 03:31 PM   #20
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My latest way to forecast is in a matrix. I take my existing assets and I FV them to ages 65, 60, 55, 50 using real rates from 1 to 8 percent. I then show safe withdrawal rates of 3 to 6 percent (with 6% meaning annuitize everything). I then manually color code all the ones that generate my projected expenses. For ages 60 and 65 I do a with and without assuming my projected age 62 social security with about a 25% haircut baked in.

I repeat the process using my projected retirement funds from my "5 year" plan. By having an income focus I am not particularly focused on "the number", even though applying withdrawal rates to the number is just math. I find it helpful to see that even with pitiful real returns age 60 is in the bag already (I am 40) and I am really not saving for retirement anymore. I am now saving for early retirement.

I also run firecalc and other calculators, but I have an affinity for my own spreadsheets.
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