What do you use as estimate (guess) regarding future rate of return?

[Niuatoputapu]

I use 5% nominal, 2% real return, because it is a conservative estimate of past returns on a balanced portfolio, and lower returns are likely in the future.

+1, based on an 65/10/25 Stock/RE/Fixed portfolio

Actually, I forecast a negative 8.75% return in year 1, followed by four years of positive 8.75% (then repeated) and that provides a 5% nominal return over every five years. This prepares me for the next correction and (recently) allows my portfolio to happily exceed Year 1 expectations.

 

[audreyh1]

Without making an estimate of your expected returns, how do you know if your AA can meet your long term goals?

During accumulation phase, probably important.

I don't think it's necessary to look at expected returns in retirment (when withdrawing). For that we choose an AA that has good survival characteristics and that we can live with (i.e. Sleep at night)

 

[fanmail]

at current levels

stocks 5%
bonds 3%
inflation 1.5%
savings 1%

 

[Big_Hitter]

Without making an estimate of your expected returns, how do you know if your AA can meet your long term goals?

oh, this is for personal reasons?

my "go forward" AA is 70/15/15 - should be 4-5% ish real rate of return

my "rollover" AA is 50/10/40 - should be 3-4% ish real ror

 

[Fishingmn]

I use a 2.5% real return.

I feel pretty confident about that number as over 1/3 of my return is made up of rental properties that are returning 10% and should be somewhat inflation protected as rents tend to rise with inflation.

 

[RISP]

I'm planning with a hair over 4% real for a 70/20/10 portfolio, but hope for slightly more.

 

[RISP]

I use a 2.5% real return.

I feel pretty confident about that number as over 1/3 of my return is made up of rental properties that are returning 10% and should be somewhat inflation protected as rents tend to rise with inflation.

You expect 2/3 of your portfolio to not even keep up with inflation? That strikes me as overly pessimistic.

 

[arky]

All my projections have always used a 1% real return. So far, I've been happily surprised every year.

+1

 

[Cobra9777]

My retirement spreadsheet assumes 4.4% nominal and 2.6% inflation, so 1.8% real. AA is in my signature. The 4.4% is based on Rick Ferri's 30-year asset class expectations matched to my portfolio (as best I can), plus a 1.5% haircut across the board. I expect we'll do much better than that. I use this spreadsheet for tax planning and withdrawal strategy what-if's, but I prefer FIRECalc and ******** for estimating portfolio survival probability.

 

[W2R]

Like Audrey, I don't pay as much attention to expected returns in retirement as I did during accumulation phase. In retirement I chose an AA that I can stick to no matter what.

Before I retired I was using 2% or 3% real return in my computations. That far underestimated my real return during the first five years of my retirement, but then with this boom market one might expect that to be the case.

Now that I am retired there is no point in computing portfolio growth; whatever it is, I'll have to work within that version of reality because I don't plan to work again. That said, it looks like possibly I might be fine even with 0% real return or a little less. In retirement I have not been spending every last cent that I could spend, not out of an excess of frugality but simply because I am happy with my present lifestyle and the way things are right now.

But then, I am glad that I have a little leeway because no major repairs or other financial hazards have occurred so far during the first five years of my retirement.

 

[papadad111]

4.4% nominal and 2.6% inflation, so 1.8% real.

The 4.4% is based on Rick Ferri's 30-year asset class expectations matched to my portfolio (as best I can), plus a 1.5% haircut across the board.

So a 45% buffer? 1.8% real vs 3.3% real is quite a difference !!!

 

[racy]

Hi palo,
My expected return depends on my mood at the time (from greedy to fearful and points between); just change the number on the ol' spreadsheet. Generally, I'm very conservative: the current number in the spreadsheet is 2.6%. Is that right? Who knows. Check this 2014 article for a variety of forecasts (scroll down): Expected returns: Estimates for your financial planning
Good luck!

 

[steelyman]

While working, I targeted 7% annual return for my retirement portfolio. Now I use 6%.

I don't use safe withdrawal rates for projections (nothing against them), instead a "target annual amount" based on a percentage of my salary, adjusted yearly for 3% inflation.

 

[Cobra9777]

So a 45% buffer? 1.8% real vs 3.3% real is quite a difference !!!

Here's the pertinent portion of my post that you omitted:

I expect we'll do much better than that.

Again, for portfolio survival estimates, I prefer FIRECalc and ********. For tax planning and withdrawal strategy what-if's, I have to make an assumption, so I use 1.8% real. In practice, I usually test what-if's against a wide range of real returns, and I only tie to Ferri's data as an independent comparison point. But yeah, as I've said in other threads, once I've got a few more years of ER experience and start gaining confidence, I'll probably loosen the purse strings, as it looks like the kids are going to make out like bandits.

 

[racy]

... I don't pay as much attention to expected returns in retirement as I did during accumulation phase. ...Now that I am retired there is no point in computing portfolio growth; whatever it is, I'll have to work within that version of reality because I don't plan to work again. ... But then, I am glad that I have a little leeway because no major repairs or other financial hazards have occurred so far during the first five years of my retirement.

Hi W2R,
Maybe in your situation you don't need to pay attention to returns in retirement, but I think many do in order to keep pace with inflation. One doesn't need to work to watch expected returns: it's more a matter of allocation. Agree?

And, BTW, you're due for a major repair/financial hazard!

 

[ERD50]

If don't think that using static returns is very useful or insightful, other than for a reference point.

But to provide a simple reference, which I don't think I've seen commented here, for a XX year period, wouldn't zero real returns provide for a 1/XX WR (which would be 2.5% for a 40 year period)?

But that doesn't account for volatility in portfolio value, or for returns. Drawing down the portfolio while it sinks, or isn't providing above inflation returns drops it forever going forward.

Can anyone explain - what question are you trying to answer with any assumption on future returns (real or otherwise)?

edit/add - OK, I just noticed this exchange:

For what purpose am I making this guess?

Without making an estimate of your expected returns, how do you know if your AA can meet your long term goals?

Strikes me as circular - I can't make an estimate of whether I can meet my goals unless I make an estimate of my expected returns? Either way, I'm making an estimate.

-ERD50

 

[Options]

I don't use any 'number' - a single number does not include the volatility of markets and inflation, and the timing of pensions and SS.

I do use the historical reporters, like FIRECalc, to better understand how my portfolio would have done in past real-world conditions.

-ERD50

+1

All these numbers are not meaningful unless the asset allocation is known and whether one is stating what they actually expect to happen or if they are just using a safe return.

Yes.

2.95% real based on "Cautious" spending using ESPlanner Monte Carlo. AA of 55/35/10.

I use the conservative mode, which assumes I earn a real return of zero (merely keeps up with inflation) in MC mode. In Upside, assuming all risky assets lose value, and safe assets earn 2%. As noted in above posts, assuming no real return is exceptionally conservative, as am I. For this reason, I'm only 40% in risky assets. Research has shown retirees are generally more interested in making their $ last a lifetime than with the size of the pot at the end (legacy goals notwithstanding). I agree with this rationale and act accordingly.

 

[Totoro]

Can anyone explain - what question are you trying to answer with any assumption on future returns (real or otherwise)?

In my case: what kind of life (spending) can I afford now, and how will that impact my capacity to spend in the future?

Or differently put: what will my lifetime earnings be from this point onwards?

 

[photoguy]

Can anyone explain - what question are you trying to answer with any assumption on future returns (real or otherwise)?

Here's a simple one: I have a portfolio of 500k and would like it to grow to 1M in 10 years. Will a 60-40 (equity-bond) AA get me there or do I need to take more risk and use say a 80-20 or 100-0 portfolio?

I'll come with an example for a drawdown scenario later.

Strikes me as circular - I can't make an estimate of whether I can meet my goals unless I make an estimate of my expected returns? Either way, I'm making an estimate.

Yes and no.

There is an iterative/circular part where I check to see if my AA will meet my long terms goals -- if not then I might adjust my equity/bonds balance and recompute the expected return for my whole portfolio as per the example above.

However it's not circular in that the basis for the expectation is computed completely separately from my goals. For example, to get an expectation of the equity component I might use 1 / PE10 (Schiller PE). This part only flows forward and isn't recomputed.

 

[palomalou]

We have dialed stocks back a bit since semi-retirement 10 months ago. Now about 50/30/20.


Sent from my iPad using Early Retirement Forum

 

[Choices]

6 nominal 3 real which is what I think my friend Warren projects.

 

[ERD50]

Originally Posted by ERD50 ...
Can anyone explain - what question are you trying to answer with any assumption on future returns (real or otherwise)?

In my case: what kind of life (spending) can I afford now, and how will that impact my capacity to spend in the future?

Or differently put: what will my lifetime earnings be from this point onwards?

And how do the responses here on what they are doing now provide any insight to that question?

Here's a simple one: I have a portfolio of 500k and would like it to grow to 1M in 10 years. Will a 60-40 (equity-bond) AA get me there or do I need to take more risk and use say a 80-20 or 100-0 portfolio? ....

Wouldn't a historical report be a better way to see what AA's have provided the returns you are looking for in that time frame?

-ERD50

 

[Looking4Ward]

I'll be 55 this year, and have 15 years worth of living expenses in a 65/35 taxable account.

I've got another 15 years worth of living expenses in a 75/25 IRA that I won't be touching until I start drawing SS at 70.

Anything above 0% would be fine with me.

 

[photoguy]

Wouldn't a historical report be a better way to see what AA's have provided the returns you are looking for in that time frame?

I don't think they're mutually exclusive. In general, if there's multiple ways of doing an analysis I'm a fan of doing them all because each method has different pros & cons.

However in this case there could be multiple reasons why one would prefer to compute an expected return instead of using a historical report:

(1) Historical reports don't consider important factors like valuations for equities or current yields in bond returns.

(2) A huge source of noise in returns is due to fluctuations in what investors are willing to pay for a dollar of earnings. Going to an expectation model can allow one to filter that out whereas those fluctuations are going to be in the historical data.

(3) Historical data may not be available for your asset class. Sure S&P has been around for ~100 years but what about more specialized asset classes like international reits, emerging market small cap value?

(4) Even if historical data is available there might be changes in regulations, accounting practices, etc. that lead you to think it's less relevant than before.



Here's an example of how expectations might be useful in a drawdown scenario. It's nothing earth-shattering and probably just common sense, but here goes:

Suppose I want to figure out what withdrawal rate to use for my retirement given that I'm willing to accept a 5% failure rate over a 30 year period. How do I determine what percentage I should use?

The first thing I might do is go to FIRECALC and see how different WR fared historically. FIRECALC says that historically I can pull out 4% with only a 5% failure rate. But everybody knows that FIRECALC is about the past and doesn't say anything about the future. So what should I do?

I figure that I have three different options:

(A) I decide that 4% is pessimistic for the future and I should pull out more than that.
(B) I decide that 4% is about right for the future and I should pull out that amount.
(C) I decide that 4% is optimistic for the future and I should pull out less than that.

Expectations on returns can tell us which scenario (A,B, or C) is the most likely. For example say the equity data in FIRCALC has an average return of 7% real (I'm not sure of the exact number). I compare this to the estimate of returns based on current valuations and lets say that's 4% real. This clearly tells me that I'm in scenario C. It doesn't tell me how much of a haircut I should take but I know that if my expectation is 4% real I should take a bigger reduction than if my expectation is 6% real.

 

[ERD50]

Wouldn't a historical report be a better way to see what AA's have provided the returns you are looking for in that time frame?

I don't think they're mutually exclusive. In general, if there's multiple ways of doing an analysis I'm a fan of doing them all because each method has different pros & cons.

However in this case there could be multiple reasons why one would prefer to compute an expected return instead of using a historical report: ...

Suppose I want to figure out what withdrawal rate to use for my retirement given that I'm willing to accept a 5% failure rate over a 30 year period. How do I determine what percentage I should use?

The first thing I might do is go to FIRECALC and see how different WR fared historically. FIRECALC says that historically I can pull out 4% with only a 5% failure rate. But everybody knows that FIRECALC is about the past and doesn't say anything about the future. So what should I do?

I figure that I have three different options:

(A) I decide that 4% is pessimistic for the future and I should pull out more than that.
(B) I decide that 4% is about right for the future and I should pull out that amount.
(C) I decide that 4% is optimistic for the future and I should pull out less than that.

Expectations on returns can tell us which scenario (A,B, or C) is the most likely. For example say the equity data in FIRCALC has an average return of 7% real (I'm not sure of the exact number). I compare this to the estimate of returns based on current valuations and lets say that's 4% real. This clearly tells me that I'm in scenario C. It doesn't tell me how much of a haircut I should take but I know that if my expectation is 4% real I should take a bigger reduction than if my expectation is 6% real.

I don't see it. Looking at failures, FIRECalc is pessimistic.

OK, I kinda see where you want to go, but not how you get there.

First, probably a minor mathematical shorthand on your part, but for clarity, a 4% static real return provides for far more than a 4% WR for 30 years. One can take 3.33% (1/30) with zero static real return.

So now you want to go more pessimistic that any past period. OK fine, so where do you get the data to tell you what to use? You say that 'Historical reports don't consider important factors like valuations for equities or current yields in bond returns.' - well sure they do, they do it on the pessimistic side. The failures are due to jumping in at high valuations. So where do you get your data to make an estimate?

FIRECalc shows a 3.59% WR at 100% success for 30 years, so that indicates the worst in history was just a bit above 0% real (again, ignoring volatility, which we can't) that would be safe for a 3.33% WR (I'll do the math later).

I'm not sure where to logically go from here - it all seems so circular. I'm an Occam's Razor kind of guy. I don't know what the future holds so I look at the past, and make a guess about how much buffer I need. You are also making a guess, but you put your guess into an estimate of real return, and then you seem to want to say those resulting calculations have more value than the initial guess - but they are just the result of a guess. Just go with the guess.

I'm not getting it.

But to answer a previous question you had, I base my AA on the range that has provided the best portfolio survival in the worst historical periods (that's an 'investigate' option in FIRECalc). I have no basis to say that a higher or lower AA will be appropriate in a hypothetical record-setting bad future. I also notice there isn't a lot of sensitivity either - roughly 40/60 to 95/5 provides the same safety factor historically. I don't worry much about it. I think middle ground looks good, and see no basis for any other thinking.


-ERD50