Have you ever thought about the day when you will be retired from your work? Consider that day when you will have to work no more, and then your biggest problem will be what next? Therefore, a creative retirement plan is a...Read more »
Making the right assumptions about future rates of return is critical.
Investment returns assumptions can be an Achilles' heel in retirement analysis, and standardization is yet to emerge, even in the academic research. For instance, Gustafson, Boldt, and Bird (2005) base their discussion on historical returns from 1926-2003, with unexplained adjustment, and Ervin, Faulk, and Smolira (2009) make similar assumptions with a later version of the Ibbotson's Yearbook. Others go back even further, like Basu and Drew's 2009 study which uses the 1900-2004 interval. Phau (2011) also analyzes this longer period, but notes that the consideration of only US data perhaps results in overly optimistic assumptions when compared to results from other countries' markets, which may perhaps presage the next US equities era, to retirees' detriment.
Other, later work uses more modern periods (Schleef&Eisinger, 2011, 1970-2008), and some (Phau, Jan. 2012) suggest methodology for advisors to insert their own market returns assumptions into their retirement planning calculus.
There are several profound problems with using historical data as a projection foundation. The first is data quality. It seems quite likely that the further back one reaches, the greater the chance that error, incompleteness, or quanta definition (how are earnings defined, for instance, or was that a dividend or return of capital back in 1916?) incomparability has crept in. The second issue embraces similar concerns with (even modern) non-US data. The third is period cherry-picking: using more or even very recent data (such as 2009-current) can distort projections disastrously. A forth is a lack of correlation of market results with underlying, complex, and constantly morphing economic trends, which, for instance, deeply distort bond market expectations if based on the past thirty years.
In the end, future returns' magnitudes and sequences are unknowable, a phenomenon not likely to change (if it did risk premia would likely collapse and the word return might lose much of its meaning). In light of this ignorance, prudence dictates more conservative assumptions, or at least those in which the client is fully engaged in the potential disaster engendered by more aggressive assumptions. In a constantly changing world, a regularly-adjusted, iterative planning approach is probably best, at least for the portion of retirement security tied to risk-based assets. Hopefully in the future, a standardized economic consensus forecast may emerge, that planners could be expected to incorporate into their client work.
Dr. Jeff Camarda is a financial advisor located in Fleming Island & Ponte Vedra, FL. Dr. Jeff has over 33 years' experience working with local businesses and investors. More information about Dr. Jeff can be found at www.camarda.com.
This article was written by and presents the views of our contributing advisor, not the WiserAdvisor editorial staff. WiserAdvisor has qualified Financial Advisors in Jacksonville, Florida area. WiserAdvisor offers financial advisor matching service who meets your screening criteria. Following financial industry's best practice, we recommend that you talk to at least 2 to 3 advisors before making any decision. To introduce yourself to one of our advisor subscribers, please click here.
Find the Right Financial Advisor for You
Free Initial Consultation. No Match Fees. No Obligation
By James O'Brien. Recent research shows that 47% of retirees say they end up working or they plan to work after retirement. And that's not just a post-recession necessity: some 72% of retirees polled in an Age...Read more »
Ideally, you've been saving for retirement since you graduated college. Unfortunately this is rare, and there are many people who are in their 50's and still ill-prepared for retirement. When you're 50 and above, you want to...Read more »
By James O'Brien. Want to make a difference in your high-school senior's life, one that will grow into something even more significant as time goes by? Here's one way. Give the graduation gift of a...Read more »
By James O'Brien. It's an oft-cited piece of advice: If you want to maximize your retirement savings and investments -- in other words, get the most for your fixed-income buck -- then moving to a community with a...Read more »
By James O'Brien. It's almost as if history conspired against Generation X. The dot-com bubble burst at the turn of the century, disrupting many Gen-Xers who were in the early years of their careers. And...Read more »
By Anna Wroblewska. Are you a stay-at-home parent? Whether you're new to the job or have been in it for years, one thing you shouldn't forget about is retirement planning. Here's how you and your spouse can make the most...Read more »
Need a Financial Advisor in your area?
Most Popular Articles
Important Financial Articles