By Kathleen M. Fisher and Tara Thompson Popernik
"Money isn't everything," proclaimed American fashionista André Leon Talley, "but it is when you start thinking about…your retirement days." While retirement may bring more time for entertainment and family, today even prospective retirees of substantial means (or fabulous taste) may not feel confident that their experiences will match their hopes.
Indeed, retirement funds have to go a long way these days. With longevity on the increase, retirement may stretch for three, and for early retirees, even four decades. And tax rates are higher now than they've been in years. That means you're keeping less of what you make on your investments (or from your earned income, if at this point retirement is still in the future).
In addition, today's markets - especially the bond market - are not very accommodating. In a normal environment, we'd expect diversified municipal bonds to generate a compound annual total return of 4.8% (Display). But over the next 10 years, we expect them to return only 2.7%, because starting yields are low and likely to increase, reducing the principal value of bonds. We expect total returns on equities to be much higher - 7.6% a year - but still considerably below the 9.2% norm.
Click to enlargeThis tells you that for any given allocation you can't spend as much today from your retirement savings as you could in the past. When we assess sustainable spending, we plan at the 90% confidence level - meaning that we want you to be comfortable that you will not run out of money even if market returns are poor in the coming decades. Using this conservative methodology, in normal markets a 65-year-old couple who invested in a 60% stock/40% bond mix used to be able to spend the classic 4% of their initial portfolio value each year, grown with inflation. Now the figure is 3.4% - a difference large enough to make a dent in your spending budget.
If you can't reduce your spending, you may need to shift to a more growth-oriented allocation - assuming you can live with the accompanying short-term risk.
Don't assume you'll spend much less than you did when in your working years. A recent survey by the Employee Benefit Research Institute and Mathew Greenwald & Associates found that 58% of prospective retirees expected to reduce their spending in retirement, but only 48% actually did, and 21% of retirees reported spending more.
Parting the Clouds
These are daunting challenges - 100but they're not insoluble. Prospective retirees and investors already in retirement have control over actions that really matter:
- Setting their asset allocation
- Utilizing opportunities to defer taxes
- Optimizing the use of Social Security
- Setting their spending level
- Deciding when to retire, and
- Choosing a savings rate, if feasible
There are no one-size-fits-all answers. In making these decisions, the goal is to secure enough savings to fund your spending needs for as long as you may live, even in hostile markets. We call that amount your "core capital," which will change as you age, if you reconfigure your asset allocation, or if your circumstances differ from what you expected when you first built your plan.
Because of the vagaries of the markets, you're apt to find yourself above, below, or at your core requirement at various times. You should monitor these fluctuations, but they are not likely to wreak havoc with your future if your portfolio is well managed and your core capital requirement was set prudently.
Back It Up with a Solid Plan
Many people base their plans on a single-point forecast of market returns, which can lead to trouble if the markets don't match the forecast. Our approach is different. As indicated above, our estimates of core-capital requirements are based on projections of a range of investment outcomes, from stellar to poor. But most of the time we focus on the latter, because we typically advise that core capital should be sufficient to meet spending needs even if the markets are dismal.
In our next posting, we'll focus on asset allocation in retirement.
Kathleen M. Fisher is Head of the Wealth Management Group at Bernstein Global Wealth Management, a unit of AllianceBernstein. Tara Thompson Popernik is the Group's Director of Research.
Disclaimer: Bernstein does not offer tax, legal, or accounting advice. In considering this material, you should discuss your individual circumstances with professionals in those areas before making any decisions.