Guidelines for Projecting Retirement Savings
Thursday, April 19, 2018

One of the challenges of retirement planning is projecting how much money you will have in the future. For those of us who are many years away from retirement, this a big uncertainty. We can use various tools and calculators, but they often rely on us making assumptions.

The assumptions largely focus on three things: age, savings and rate of return. Age is how old you will be at your planned retirement date. This is the easiest of all the assumptions. For most people, retirement will be between 65 and 70. (The greater your ability to work to 70, the more money you will have accumulated for retirement.) Obviously, the actual date will depend on both your health and what happens to your career between now and the planned retirement date.

The next two factors are tougher to forecast. Savings is what we intend to set aside between now and our retirement date. The rate of return is what we expect to earn on our portfolio between now and then. Both are levers we can pull either through the percentage of income we set aside or the allocation we choose.

This brings us back to the commentary I wrote last week about expected values. Expected values are a form of scenario analysis. While it is certainly easier to calculate expected values when there are fixed and known odds—as is the case with Mega Million and Powerball lottery tickets—a form of scenario analysis can be done with retirement planning even if you lack complex software and/or have no idea what Monte Carlo simulation is. (A Monte Carlo simulation estimates values based on many possible scenarios.)

Let’s start with savings. You know how much you can save now. You can likely also estimate when you will be able to increase your savings rate. Your employer may conduct annual reviews. Your kids will graduate college by a certain date. Certain debt (mortgage, student loans, credit cards, etc.) will be paid off. You can reasonably assign odds to these events occurring by specific dates and make a plan to allocate the excess cash to savings. (Put a reminder in your smartphone to do so on the projected date. This will increase the likelihood of you actually allocating this cash to savings.)

Returns are trickier, but we can still assign some reasonable odds. Over the long term, large-cap stocks have realized an annualized return of 10%. Intermediate-term government bonds have returned about 5.1%. These are our baselines for making assumptions.

As long as we have an investing time horizon in excess of 10 years, we can reasonably expect the returns on stocks to be positive. [Large-cap stocks have only experienced losses on a rolling 10-year basis four times since 1926 according to the Ibbotson SBBI Yearbook (Duff & Phelps, 2017): 1929–1938, 1930–1939, 1999–2008 and 2000–2009.] We can adjust for the volatility of stocks by assigning an equal 25% probability of returns ranging between 3.5% and 7.5%, 7.5% to 12% and 12% to 16%. These are not precise, but they are more than close enough for assigning more nuanced odds. As far as the worse and better return outliers are concerned, stocks have been more likely to realize returns in the high teens than in the low single digits.

Bonds are admittedly a bit trickier because of current yields and the bull market they’ve experienced since 1982. Assuming yields on U.S. bonds don’t go below zero (which did occur in Europe), the potential upside for bonds is limited because yields are still low on an absolute basis. This is not an interest rate forecast, but rather a simple acknowledgement of math. Historically, the return on intermediate-term government bonds has been below the 5.1% geometric mean on more 10-year rolling periods than not. If you want to lean conservative, you could place the higher odds on long-term returns ranging between 1.5% and 3.5% and somewhat lower odds on returns between 3.5% and 6%. Assign an even lower probability on any return above these levels. Again, these are not exact odds, but close enough approximations based on historical data to use for planning purposes.

There is enough variance in the numbers for the projected dollar value of your retirement savings to vary depending on how you use the variables. If you add other assets to the mix, the returns will differ even more. (I’ll share more return data in next month’s AAII Journal.) Nonetheless, these numbers are arguably better for projecting how much in retirement savings you will have accumulated than uneducated guesses and forecasts dependent on a specific set of events occurring.

Like investing, forecasting is messy. Just because someone can precisely quantify the odds does not make their forecast better. You are far better off making simple assumptions based on what has happened historically, and adjusting your savings rate along the way, than relying on a specific forecast that could prove to be even more in error.

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Highlights from this month's AAII Journal

AAII Model Portfolio Update

No changes were made to the Model Shadow Stock Portfolio this month. The next quarterly review will take place at the end of May.

The Model Shadow Stock Portfolio, which is a real-money portfolio of micro-cap value stocks, gained 1.33% in March. The Vanguard Small Cap Index fund (NAESX) added 1.12% for the month, and the DFA U.S. Micro Cap fund (DFSCX) added 1.71% in March.

Since its inception in 1993, the Model Shadow Stock Portfolio has a compound annual average return of 15.4% versus the Vanguard 500 Index fund’s (VFINX) gain of 9.4% per year on average. Over the same period, the Vanguard Small Cap Index fund (NAESX) posted an average annual gain of 10.2%.

The Week Ahead

First-quarter earnings season will hit full steam with 184 members of the S&P 500 index scheduled to report. Included in this group are 12 Dow components: 3M Co. (MMM), Caterpillar Inc. (CAT), Coca-Cola Co. (KO), Travelers Companies Inc. (TRV), United Technologies Corp. (UTX) and Verizon Communications Inc. (VZ) on Tuesday; Boeing Co. (BA) and Visa Inc. (V) on Wednesday; Microsoft Corp. (MSFT) and Intel Corp. (INTC) on Thursday; and Chevron Corp. (CVX) and Exxon Mobil Corp. (XOM) on Friday.

The week’s first economic reports will be the April Purchasing Managers’ Index (PMI) composite flash and March existing home sales, both released on Monday. Tuesday will feature the February S&P Case-Shiller home price index, March new home sales and the Conference Board’s April consumer confidence survey. March durable goods orders and March international trade will be released on Thursday. Friday will feature the preliminary estimate of first-quarter GDP, April Chicago PMI and the University of Michigan’s final April consumer sentiment survey.

The Treasury Department will auction $32 billion of two-year notes on Tuesday, $17 billion of two-year floating rate notes (FRN) and $35 billion of five-year notes on Wednesday and $29 billion of seven-year notes on Thursday.

What’s Trending on AAII
  1. Are You Spending Too Little in Retirement?
  2. The Impact of Out-of-Pocket Medical Spending on Retiree’s Income
  3. Using Bonds Instead of Stocks for Portfolio Income
AAII Sentiment Survey

Optimism among individual investors about the short-term direction of the stock market rebounded to its highest level since February in the latest AAII Sentiment Survey. At the same time, pessimism fell after having reached an unusually high level last week.

Bullish sentiment, expectations that stock prices will rise over the next six months, rose 11.7 percentage points to 37.8%. This is an eight-week high. The increase was not large enough to prevent optimism from staying below its historical average of 38.5% for an eighth consecutive week and the ninth time in 11 weeks.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rose 1.8 percentage points to 33.0%. Neutral sentiment is above its historical average of 31.0% for the ninth consecutive week.

Bearish sentiment, expectations that stock prices will fall over the next six months, plunged 13.5 percentage points to 29.2%. The drop puts pessimism below its historical average of 30.5% for the first time in four weeks.

There was a reversion to the mean this week after last week’s spike in pessimism to its highest level in more than a year. The possibility of negotiations over trade and the rebound in stock prices likely had an effect.

Responses to our weekly special question indicate that many individual investors, but not all, are continuing to anticipate continued volatility and/or think that the current political backdrop could have a further impact on the stock market. Trade policy is influencing some individual investors’ sentiment. While many individual investors either approve of the recent interest rate hike or don’t expect it to affect the stock market, some are concerned about the impact that rising rates will have. Also influencing sentiment are valuations, tax cuts, earnings and economic growth.

This week’s special question asked AAII members what impact geopolitical and international events are having on their outlook for stocks. Slightly more than two of out five respondents (42%) describe these events as having a negative impact. Many specifically point to the threat of a trade war and/or the uncertainty over the president’s policies. Nearly 29% say international and geopolitical events are not impacting their outlook, while 9% describe the events as having a short-term but not a lasting impact. About 7% describe geopolitical/international events as providing buying opportunities.

Here is a sampling of the responses:

  • “Instability is a scary thing. I hope for the best, but I am starting to prepare for the worst.”
  • “May be good for energy stocks, but it may lead to more volatility for the rest of stocks. Still, earnings and fundamentals should rule over these events.”
  • “Somewhat positive as I can invest even more when everyone else is getting scared.”
  • “Making me more concerned about the economy and the stock market.”
  • “I try to limit my reactions to geopolitical/international events since they often end up being less important in the long term.”


This week’s Sentiment Survey results:

Bullish: 37.8%, up 11.7 points
Neutral: 33%, up 1.8 points
Bearish: 29.2%, down 13.5 points

Historical averages:

Bullish: 38.5%
Neutral: 31.0%
Bearish: 30.5%
Take the Sentiment Survey.

Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!