A thread from yesterday [1] got me thinking about the numbers I’m using in my financial planning software and retirement calculations.
What values do professionals run with for the following?
Inflation. My long-term calculations assume 2% inflation.
Equity-based mutual funds, SPYDERS, stocks. Some sources say 12%. Some say 10, some say 8, and apparently one says 4.6. What gives? Do some professionals really believe the market will return 4.6% long-term? If so, why buy stocks versus savings bonds? Is the 4.6% including some fancy factor accounting for risk?
“Safe” investments. What is a long-term APR for treasury bonds and other vehicles with similar levels of risk? I know what I’ve seen in the last few years, but I’m not 30 yet, so I know my sampling is limited.
Assuming my area doesn’t get better or worse, what should I plug in for appreciation on the real estate I’m in? I found some government statistic online and averaged it out over 20 years to come up with 5.6%. Is that sane?
You are getting different numbers from different sources because that is the future and it’s speculation. The only thing you can do is take ex-post (historical) data and use that as a guideline but there is no guarantee. You probably already know this.
Even professionals will come up with different historical stock returns because there are so many variables. Do you start averaging from when the stock market was created or from after World War II? Which index do you use? Most people cite between 8% and 12% as an average but you will get a lower number if you subtract inflation or a risk-free rate. With all the different answers you’ll get, it might be wise to just pick the data that you think will best reflect the future and use that to make reasonable calculations.
A big difference is that many return rates bandied about, especially those from investment firms, do NOT include a correction for inflation. But they almost never mention that that’s what they’re doing. they’re also very prone to ignore both taxes & fees.
From your terminology I assume your talking about the USA. It’s 100% possible that the inflation corrected rate of return of the broad US stock market over the rest of your life (50-ish years) is negative. Or it might be +10-ish% per year. Good professional arguments can be made for either conclusion.
Remember that every year your gains, other than unrealized gains, must first pay taxes & transaction fees on themselves. Then your realized & unrealized gains must pay any maintenance fees on the principal and then must cover inflation on 100% of the pricincipal.
Only the excess above that is a true gain you can either spend or reinvest for next year. And if you spend it you’ve got to realize it, and therefore pay taxes & tranaction fees on that gain unless it was realized already.
My personal (non-professional) working assumption is 5% over inflation for a typical balanced portfolio that’s tax-free/deferred, and 3% over inflation for one that’s not. That’s more pessimistic than the last 60 years would indicate, but I see the USA as having had a golden age following WWII when the rest of the world was either flat on its back or not yet part of the world economy. I see that special era as fading even now. Consider the history of Britain from after WWII to today; I see that as a good parellel for the USA in the 2000-2050 timeframe. Some professional opinions would laugh and call me a doomster; others would agree 100% or be even more pessimistic.
Remember that even a pure buy-and-hold (ie no realized gains = no tax drag) strategy isn’t pure. Mutual funds turn over their portfolio & generated taxable events for you even if you just buy and hold their shares. Companies grow, shrink, split, prosper, merge, demerge, declare bankruptcy, etc and if you own those shares you’re going to participate in that transaction.
Given the routine level of modern business turbulence, it’s very unlikely that any share of stock you could buy today will be unchanged 20 years from now. So do not neglect to include at least some tax drag on all of your portfolio that is not tax-advantaged in some way, e.g. 401K or IRA.
Thanks for your response. I do greatly appreciate it.
On your assumption that the USA is in an “end of the empire” scenario… well, that’s depressing as all Sheol. It is also a conclusion I’d been mulling over, and have seriously considered adopting.
I wonder whether or not the US’s Fortune 500 companies are smart enough to globalize in such a fashion as to shield themselves from the liabilities of this?
I guess since we’re playing roulette with my retirement, I’d best assume they’re not that smart.
You mention that your opinion is a non-professional one. Are you in financial services? If so, do you have a different stance professionally?
Thanks for reminding me of transaction and tax friction.
I do make my financial planning software factor in taxes, so I’m safe on my taxes on my investments.
As far as fees go, I should account for those. I suppose the sanest way is:
Add investment category average yield.
Subtract those annualized fees that come in percentage format.
Schedule fixed dollar amount fees as withdrawals on the account in question. Apply inflation to the recurring withdrawals this generates, until fund is liquidated.
Thanks for bringing the fees to mind. I do appreciate it. I’m mostly in a SPYDER right now, but as I diversify going forward I’m sure I will wind up with higher fees.
I’ve run some numbers and compared numbers, and did some research while consulting my finance department and my own personal financial advisor (btw, fwiw, the consensus of the guys in my finance dept think my financial advisor is a boob, though, I’m not complaining). Mind you, these estimates are all for back of the envelope type computing. Here’s what we got:
I assume 3%. I found it to be a majority consensus.
I found most internet sites to say 12% (though some as high as 15%). My finance department agrees, if it’s a huge index, like DOW. I’ve seen mutual funds quoted anywhere from 8-12%. I use 8%, because I want to use overly conservative estimates in the hope of being presently surprised in the future. However, in the short term, I’ve personally seen 6-8% (closer to 8%).
People buy bonds to diversify their portfolio. This is just sound, logical strategy. Despite the fact that the DOW has historically returned (I believe) 15%, (which I saw on the Motley Fool site), it is still risky to put all your eggs in one basket.
However, contrast my dad who invested his profit-sharing into the most risky investments he could find, in his last 10 years before retirement. He made a lot of money. Then again, he retired in 2000.
My financial advisor said it used to be 6% was good, upwards of 10% (iirc) in the 80-early 90’s. It looks like if you can beat 4.3% then you’re good (basically, just beat the T-bill).
My dad is a huge fan of investing in real estate. That’s how he was able to move my family out into the semi-affluent suburbs when the first emmigrated here (it helped not to have any kids and the ability to move back to his home country if his investment didn’t pan out). Anyway, I believe the government statistic is averaging appreciation across the country. There will be a lot of stagnate and negatively depreciating areas factored in. You need to look at and chart home prices in your area. I use county, but it might not work for an area like Chicago, where you will have to look at something much smaller, like a “neighborhood.” In my neighborhood, ROI has been around 9.6% (a real estate agent told me who was charting the neighborhood I wanted to live in). My county was much lower at 6%.