Question: I am retired and living off my savings. As you mentioned in your column last week, returns on bonds, money market funds, and CDs are dismal. I do have both stocks and bonds in my portfolio, and have been following the 4% withdrawal rule with the expectation that my savings will support me throughout my retirement, keep me ahead of inflation, and be available for my kids when I die. Do you think I’m on the right track?
Answer: There is no doubt that retirees living off their savings are having a tough time achieving reasonable returns on their investments. By now you are well aware of current low returns on fixed income investments: 10-year Treasuries yielding around 1.75%, 5-year CDs around 1.3%, and money market funds close to zero. Gone are the days when you could invest in five-year CDs and live off the interest.
So retirees are adding stocks to their portfolios to capture dividends and capital gains. They know that US Stocks over the past 30 years have performed well. According to a May 2016 report by McKinsey Global Institute (MGI), U.S. Stocks and bonds have provided average annual real returns of 7.9% and 5%, respectively, during that time period. (Real returns are returns above inflation). European stocks have also yielded real returns of 7.9%, while European bonds have yielded 5.9%.
Retirees also know that more recently, U.S. and European stock and bond returns have been dismal, and they are wondering what to expect. The McKinsey report is not encouraging. The title of the report is “Diminishing Returns: Why Investors May need to Lower Their Expectations” and the report is forecasting U.S. Stock real returns over the next 20 years to be in the neighborhood of 4.0-6.5% and U.S. Bond returns between 0-2.0%. Furthermore, MGI expects European equity returns between 4.5% and 6.0% and bond returns between 0% and 2%. As you can see, these forecast returns are significantly lower than the returns we have enjoyed over the past 30 years.
Using MGI numbers, the worst case scenario would be a portfolio of stocks and bonds earning, on average, 4.0% per year above inflation (4..0 % real return on equities and 0.0% real return on bonds). With your spending rate of 4%, that would leave your principal amount static and intact. Under the MGI best case scenario, with 6.5%/2% real return on U.S. stocks/bonds, your portfolio would grow significantly.
What can you do? First, make sure your portfolio is well diversified. Diversification reduces volatility, which will give you greater comfort and piece of mind because your portfolio will experience less dramatic ups and downs over time. Secondly, don’t stick with just U.S. Stocks and bonds. Add international stocks, emerging market stocks, real estate (REITS are liquid and there are excellent low cost REIT funds available), and natural resources or commodities. By adding these asset classes, you are diversifying even more and improving your chances for better long-term returns.
Kenneth B. Petersen CFP®, EA, MBA, AIFA® is an investment advisor and Principal of Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investing, taxes, retirement, or estate planning. Send your questions to: Ken Petersen, 2340 Garden Road Suite 202, Monterey, CA93940 or email them to firstname.lastname@example.org.