by Mike McKay and Clete Miller, LongView Wealth Management
Advisers analyze markets and make assumptions in order to forecast how much savings are required now to successfully meet retirement goals later. People are living longer, causing an obvious increase in the amount of money needed to fund a prosperous retirement. For advisers to calculate the growing amount of money needed to fund a retirement plan, they look at current market prices to predict future returns. With market prices at an all-time high, future returns are expected to decline. This combination of longevity and lower returns creates a double whammy for investors.
Example: assume a household earns $50,000 at age 25, expects a 3% annual growth rate in income, and wants $1 million in purchasing power after age 65. If a 5% real return on investments is achieved, they will need to save 10% of their income each year to reach their goal. However, if the real return drops down to 2%, they will need to save 18% of their income each year to successfully reach their goal by age 65 (Morningstar, Blanchett, Finke, Pfau. 42).
People living longer is good news. However, as retirement seekers, we must understand the financial impacts associated with funding a longer retirement. Life expectancies for older people have increased significantly over the past 100 years and are expected to continue increasing. Men and women who reach age 65 in America are expected to live to 81 and 84 respectively.
Historical evidence gives insight that high stock and bond prices today will lead to lower investment returns in the future. Likewise, the low yield on more secure assets today, paired with increased longevity, has doubled the cost of buying guaranteed retirement income since 1980. Investors who bear the insecurity of a riskier equity portfolio, in hopes of softening the blow of projected low asset returns, are unlikely to achieve their goal through this process. The idea of taking greater risks and saving less seems more entertaining in the present sense, but we must think about the future. We cannot find ways to treat the symptoms; instead, we must cure the problem. The insinuation of lower projected future returns can only be reversed with more savings. The risk of presenting unrealistic and fortuitous scenarios will allow us and our clients to believe they can accomplish their long term financial goals without the sacrifices demanded from a potential low-return environment.
The combination of a decline in future market returns and increased longevity will require households to save significantly more to maintain the same standard of living in retirement. Due to the sacrifices in their current lifestyles, many individuals will not be able to accept saving a quarter of their earnings. The only way to avoid this lifestyle change is delaying your retirement. Postponing your retirement will decrease your retirement life, thus increasing how far your savings and Social Security Benefits will stretch. As earning workers, we must consider which option is better for us… Do we want to work longer and enjoy more of our money now? Do we want to save more now and enjoy our retirement sooner? I know we all love work… But our goal here is to reach financial independence and retire. Let’s find a way to balance our savings and work life-span!
Blanchett, David. Finke, Michael. Pfau, Wade. “Contributions Are Paramount for Retirement.” Morningstar February/March. 2017 42-45. Print.