Planning for low returns

[perez99]

Hello
I usually use Firecalc with the calculations default of "Total Market", and just adjust the % of equities to my AA (in this case 60%).
I expect to retire at the end of 2020 at age of almost 57.

With all the noise of potential lower returns, I wanted to see how my projections will change if indeed that was the scenario. I don't expect to change my AA or retirement date, so its idle curiosity at this time.

Seem I can use one of these options:
1- A portfolio with consistent growth of X% and an inflation rate of Y%
2- A portfolio with random performance, with a mean total portfolio return of X% and variability (standard deviation) of Y%. Assume an inflation rate of Z%

For me these options drive very different outcomes when using returns like 4% and inflation of 3%.

What would be your preferred way to model low returns?

Thanks!

PD: Long time lurker. Very few post. Learned a lot. Need to write the full intro to the group. On my To-Do list...

 

[pb4uski]

I think you are being way too conservative with a 1% real rate of return for a 60/40 portfolio.

The projected inflation rate is the base for investment returns.... a real return of 1% for a 60/40 portfolio for a 30 year period is unrealistic... the average real return for a 60/40 portfolio is 5.8%.... the worst for a 20 year period is about 4%.

For my own deterministic planning I haircut nominal 8.6% historical 60/40 returns by about 30% to 6% and include 2.7% historical inflation... resulting in a 3.3% annual real rate of return... more than 40% less than the historical average of 5.8%.... IMO that is plenty conservative enough.

Also see https://portfoliocharts.com/portfolio/classic-60-40/

 

[Jerry1]

I think the most conservative option in the Fidelity planner is “below market average”. I think it basically just covers the expected inflation. There’s is very little growth and in fact you end up spending down your money toward the end. Success is having any money left in the end (35+ years for me). I think that’s conservative enough. Just average returns makes a drastic change. So my goal was to look good under the below average returns assumption at my higher than expected spending range. Then, if things get even worse, I can cut back on some spending. Pretty conservative. I wouldn’t retire young, unless for something beyond my control, without a pretty conservative modeling of my plan.

 

[COcheesehead]

For Firecalc, put fixed income at the 5 year treasury rate and equities at 0%. That should get you pretty close to worst case.
The Fidelity calculator also figures in SORR in the below market average case, taking a slice off your portfolio from day 1.

 

[Dtail]

For the calculators where one can control the return/inflation numbers, I use 5.5% nominal and 2.5% inflation for a net 3.0% real return.
This is plenty conservative.
I also use the Fidelity calculator under the "significantly below average" results which gives fairly conservative results.
Remember that Firecalc is already taking into account the worst historical sequences and that is the basis of the 4%WR in the first place.

 

[W2R]

For FIRECalc I just use the same inputs as always, total market with fixed income being 5 year treasuries and my own asset allocation. Then, I make sure that there is sufficient room between what it says I can spend, and what I actually need to sustain life.

If returns are low, or if we have another big recession, or other adverse circumstances affect me, I can always cut back without having to resort to eating dog food and living in a box under a bridge. I'll still have more than enough to live my present lifestyle.

During better times, I can spend the excess on fun stuff, doo-dads from Amazon, or whatever.

We haven't had massive inflation yet during my ten year retirement, but I think that could be a lot more challenging to deal with than low returns. My strategy of planning with a bit of overkill will help in that case as well.

 

[perez99]

Great inputs. Appreciated

 

[GravitySucks]

30% drop year 1
10% drop year 2
0 real gain year 3 to 7
Revert to 5% year 8 to 40
Which turns out to be close to what Fido returns on Significantly Lower setting.

 

[street]

I would say there most likely won't be much planning for lo returns for the ones with 0 or less then 1 percent WR. With no WR I would just weather the storm and wait for better days ahead. If you depend on a 4 to 3% WR then you will need to came a plan.

 

[davebarnes]

I think the most conservative option in the Fidelity planner is “below market average”.

Actually, the Fido default is "significantly below average".
If my wife's end-of-life number is positive, then I am happy.

 

[Scratchy]

Does anyone know what real rates of return correlate with Fidelity in their retirement planner "significantly below average" model?

 

[Al18]

According to the important information listed on the last pages of the Fidelity Retirement Analysis report I ran earlier this year:

"Inflation Rate Assumptions
The Tool assumes an average annual inflation rate of 2.5%, which is based on the average historical rates and a target rate of 2% set by the Federal Open Market Committee (FOMC)."

 

[Senator]

Planning for much higher taxes, vs. Lower returns is going to be a better strategy.

Plan on taxes being double what they are.

 

[pb4uski]

.... Plan on taxes being double what they are.

Any basis for such radical thinking? or just your personal opinion?

I agree on the up direction, but I have not read anything suggesting a doubling of taxes.

 

[MichaelB]

This isn’t the right thread for a discussion on tax rates or policy. If you want that, please start a speparate thread.

 

[Senator]

This r ally isn’t the right thread for a discussion on tax rates or policy. If you want that, please start a separate thread.

Sounds good.

 

[Dtail]

According to the important information listed on the last pages of the Fidelity Retirement Analysis report I ran earlier this year:

"Inflation Rate Assumptions
The Tool assumes an average annual inflation rate of 2.5%, which is based on the average historical rates and a target rate of 2% set by the Federal Open Market Committee (FOMC)."

That's true on the inflation side.
Not sure if there is any information on the nominal portfolio return side to complete the real return equation.
Then again with Monte Carlo simulations, not sure how that would be calculated anyway.

 

[COcheesehead]

That's true on the inflation side.
Not sure if there is any information on the nominal portfolio return side to complete the real return equation.
Then again with Monte Carlo simulations, not sure how that would be calculated anyway.

Can’t you just run the tool and look at the results in the table format and kinda, sorta work backwards? Not easy, but it will give you an idea.

I personally don’t really care what the return percentage is as long as I meet my goals with a reasonable buffer. In my case I add 33% on top to be safe.

 

[GenXguy]

Hello
For me these options drive very different outcomes when using returns like 4% and inflation of 3%.

I'm a few years younger and plan to FIRE in 2020 or 2021, but I just look at the worst case of the real return being 0%, thinking my stash will at least keep up with inflation on average over 20 years. I'm at a conservative 42% equities and can tolerate a stretch of down years.

Even at a 0% real return, I will will be able to maintain my planned 3.3% WR until SS kicks in at 65, when I can reduce my WR to 2%, all while more than half of my spending is discretionary. And if things get a little tight financially at age 65+, I can still pay my required expenses with a WR of 0.2% by cutting down on discretionary spending for a while, or direct discretionary spending towards unexpected expenses if required expenses are unusually high at some point, perhaps only temporarily. So there's plenty of buffer in my plan.

Mathematically, I should be able to spend even more than my plan allows, and I may very well do so if things go well, but the WRs I just mentioned already provide many times more discretionary spending than I have spent in any one year over the last 5 years or so, so I've come up with the 3.3% WR (2% @ SS age) as a combination of safety and comfort (including dining out, hobbies, entertainment, travel, and misc. discretionary). With my lifelong frugal ways and a shift toward being more minimalistic in recent years, even 3.3% WR feels a little high looking forward in dollars, so it will be interesting to see if I'll actually get myself to ramp up my discretionary spending that much in retirement despite having a lot more free time than I have now while still working.

 

[Gumby]

Latest nominal return projections

You have to choose your own inflation projection, but the current nominal projections are fairly low for the next ten years. With even a relatively low amount of inflation, a portfolio may have a difficult time sustaining a "4% rule" draw.:

Recent projections for U.S. Equities for next 10 years

Vanguard -- 3.5 - 5.5 % https://advisors.vanguard.com/insights/article/IWE_InvComMktPrspctvsOct2019

Black Rock -- 6%
https://www.blackrock.com/institutions/en-us/insights/charts/capital-market-assumptions

J.P. Morgan -- 5.25 - 6%
https://am.jpmorgan.com/us/institutional/ltcma-2019-executive-summary

 

[ncbill]

You have to choose your own inflation projection, but the current nominal projections are fairly low for the next ten years. With even a relatively low amount of inflation, a portfolio may have a difficult time sustaining a "4% rule" draw.:

Recent projections for U.S. Equities for next 10 years

Vanguard -- 3.5 - 5.5 % https://advisors.vanguard.com/insights/article/IWE_InvComMktPrspctvsOct2019

Black Rock -- 6%
https://www.blackrock.com/institutions/en-us/insights/charts/capital-market-assumptions

J.P. Morgan -- 5.25 - 6%
https://am.jpmorgan.com/us/institutional/ltcma-2019-executive-summary

similar to projections immediately post-Great Recession.

 

[Gumby]

similar to projections immediately post-Great Recession.

If you click on the JP Morgan link and look at Exhibit 11A, you'll see that they were projecting substantially greater returns for a 60/40 portfolio in 2008 than they are in 2019. To wit, approximately 7% in 2008 and approximately 5% in 2019.