Man Proposes, God Disposes: An Expanded And Cautionary View Of Retirement Planning Assumptions

by: Jim Sloan


My son asked a good question about return assumptions for the next 30 years, which opened out into a number of larger questions concerning retirement planning.

Retirement planning hint: look backward 30 (or however many) years and assume there will be as many disruptive financial events in the next 30, but don't stop there.

Underlying all such questions is an underlying truth: man proposes, but God disposes.

One of the key retirement planning issues is achieving a good balance between present needs and wants and future needs and wants.

Good values are very important, and my son helped me increase my awareness of some important values that are not always obvious.

"Homo proponit, sed Deus disponit (Man proposes, but God disposes)" - St. Thomas a Kempis, The Imitation of Christ

The end of the year is a good time for asking questions about retirement planning and assumptions. The other good times are whenever you have two or three hours without other tasks that have to be performed immediately. Now that I am actually retired, sort of, I tend to think that I have put these questions behind me, but a question from my son made me start thinking again.

I am lucky to have a very smart, frugal son (age 46) who is a good family man with a very fine wife and three daughters; one in college and two soon to be. Having achieved some visibility and control of the children's education phase of financial life, he is doing exactly what I was doing at his age -- working out how he needs to save to cover the whole range of possible needs in retirement. It carries me back to a time when I scrimped and saved to be absolutely, redundantly sure that I had all the bases covered.

My son sent me this email:

I'm running some scenarios. What do you think about these assumptions in calculating retirement savings...

1. Over the next 30 years the assets I currently have in savings will grow at 5% per year (nominal - this is before considering inflation).

2. Over the next 30 years, inflation will run at 2% on average.

Higher or lower on the two? And we're talking long, long term, Is 5% about right given the starting point now with asset values or still too high?

I thought this was a damn good question to start with, and his number in fact roughly comported with a recent piece I read on SA. I also knew my opinion on this subject, as well as my reasons, neither of which exactly comported with those of the other SA piece. But the more I thought about how to answer, the more I realized that this particular question opened out into a much larger kind of question.

Here is what I wrote back:

I am not sure what I think. Remember Tom Brown? (Note to SA readers: my best tennis friend -- not his actual name, of course.) He asked me a similar question around 1990, maybe earlier, much more naively, of course. He had done well and wanted to retire early. I told him to estimate the number of years he might live -- I think we guessed thirty, or maybe forty -- and then suggested we look back into the past thirty or forty years at the kinds of things that had happened in the world over that period. In his case this included the significant inflation of the 1970s, which absolutely killed most assets retirees had, followed by the kind of stock and bond boom that might come too late for the Monte Carlo result of having drawn down too much of one's assets too early. I urged caution.

I still think this was the right way to expand Tom's narrower question. Events, however, took off and ran away with all analysis. As it happened, Tom got sick and died within a bit over a decade, his beloved daughter worked unsatisfactorily for me as an assistant tennis pro and was in dire straits by the last report I had of her, and his wife, who had no particular financial savvy, was left to figure the world out. But that's another story. It's unique and atypical. Or is it?

I have some reluctance when it comes to linear return and inflation estimating. It's sort of a Vanguard thing, and you can Monte Carlo it to death (but again limited in usefulness by the level of accuracy of inherently uncertain assumptions) but you also must never forget one thing: "man proposes, God disposes" -- "God" being place-holder language for whatever you happen to believe in. My personal approach has always been a full-court press -- always work, always save, always invest with the maximum diversification you can figure out, always take care of yourself, never accept anything at all as certain. You should try to live in a healthy place which might survive armageddon, you should own stocks, bonds, trees, cash, vitamins, antibiotics, rifles, etc -- the stuff that could get you through a couple of bad weeks in world history. You hope never to need many of these things. What you really need (and what you can't entirely control) is your own health and vitality.

I think GMO is pretty much to the point when it comes to bounding your horizon. (Note: GMO, for SA readers not already familiar with it, is a giant money manager that puts out regular seven-year return estimates on its website.) I think seven years is about as far as I tend to go when trying to come up with investment return models. Trees probably hit your bogeys pretty well over that period, other portfolio components are likely to get you (expletive deleted). If I went out ten years, which I sometimes do, I still think stocks before dividends are essentially about zero from here if fairly valued at the end, and bonds are their coupons. I have no clue on inflation, but barring very extreme policy decisions -- much more extreme than the present or recent past -- the predominant inflation rate will probably be driven by demographics and will be very low, perhaps deflationary without intervention.

Trees have odd and idiosyncratic risks, of course, especially if you can't really diversify your timber holdings, and the only other decently priced asset class is emerging markets, which are even more idiosyncratic and beyond my capacity even as a traveled person with historical knowledge. So trees, inadequately diversified, are still my best oddball bet.

All that being said, I think your estimate going out thirty years is about right to slightly low if you are modeling the most likely thing in the financial markets. Your 2% inflation rate is the historic 3% inflation rate looking 100 years backward adjusted for the current and ongoing deflationary starting period. Your return estimate might be the historic 10% nominal stock return and 4-5% nominal bond return modified by the fact that stocks are pretty expensive by many longer term metrics and will not again be swept up by a rerating upward in the US PE multiple like that which took place between 1915 and the present. Maybe stocks will do a little better than that, especially if there is a modest pickup in inflation. But the variance possible in the course of the journey, which could come at any time, makes the 30-year estimate less than entirely useful.

You know what you should check out? Comb through a bit of Cramer, who is not always entirely dumb, for his views on various disruptive technologies, maybe starting with his recent list of 38 "anointed" favorites. Don't think of buying them, of course. Instead just look at them and consider what they imply for other parts of the market - then think of as many other disruptive technologies and business models as you can come up with. Armageddon may in fact not be terrorists or revolutionaries but a radical overhaul of business methods. Beyond that there is the general problem of the increasing obsolescence of human beings, especially those who aren't clever and skilled. What is the world going to do about them (about us?), politically and economically? How will their plight impact us, you and me? What are our responsibilities, yours and mine?

I suppose I am just brainstorming this problem in a slightly silly way, but the reality is that one or two unpredictable complications are likely to occur even in the rest of my life, and the implications are likely to swamp linear forecasts. I think you have to know everything, learn everything new, and maximize for handling everything that may come up. Return estimates are at best a starting point.

My son, who is the same kind of OCD person about this stuff as I was at his age, responded with a very detailed Excel spreadsheet enabling very detailed examination of very detailed assumptions about saving, investments, and spending needs. He also, however, added these important thoughts:

As you know, I'm a huge saver, and barring some sort of disaster (job loss in a couple of years, big money-draining illness) I'm probably OK under a wide variety of assumptions. But that's actually one reason I'm spending an inordinate amount of time looking at the issue right now. As big a question as "am I saving enough" is for someone in my situation, the question of "am I saving too much" also starts to have merit.

Not that I want to go on a wild spending spree. But I keep such a tight lid on spending that it sometimes causes friction with Nicole and the kids -- or, at least, makes life a little less pleasant than it could be. If there are little things that we can spend a little more on, like a nice dinner here or there, or a car that has heated seats for the winter, how should I look at that? If saving is just delayed consumption, am I at a place where a little more consumption now at the expense of a little less consumption three decades from now is the right call? This is in my mind, and it has prompted me to play around the (Excel) exercise.

I told you about our new BMW electric. It obviously costs more than my Honda Fit, which fits my worldview on transport (similar to yours). (Note to SA readers: I myself drive an old Honda Civic, perhaps the last car ever made with hand cranked windows). But after initial resistance to the idea of upgrading to a new level with cars, I caught myself and started running the numbers (Note: in an earlier email he had sold me completely on the idea that this electric BMW is reasonably priced after the various bribes governmental entities pay you to buy it), and it helped me come to the realization that it was no big deal to relent on a nicer car -- at least in the grand scheme of things. Of course, the funny thing is I now LOVE this new car. Butt warmers have appeal, and it has built-in satellite radio, free the first year, that gets CNBC! It's for Nicole to commute to school, but now I want my own in place of my Fit.

What caught my attention were his reflections about quality family experience. Quality family experience is everything. I have always thought that families who toil together daily for crusts of bread, if not actually starving, are pretty much as happy as the very rich -- maybe happier. But my son and I live somewhere in the middle, neither major-multi-millions nor bread crusts. I realized that he had put an important question in focus. Here's what I wrote back:

The Excel workup was interesting. The thing to remember is that it is background, but the real world upsetters aren't just rates of return and inflation but events which change everything. The best rule, I think, is the Buffett/Munger rule that it is better to be broadly right than exactly wrong.

The things kids want are generally dumb, and I wouldn't pay too much attention to them except when in an indulgent mood. One of the things I harped on with you and your sister was that you needed to ignore what other kids did or wanted as possessions and be strongly individual within the context of family values. Both of you have done that. What one should splurge on for kids is the tools to accomplish things -- a trip or experience they will like but also profit from.

Wives are a different story. I certainly think that at this point you two should not deny yourselves trips, experiences, dinners out -- the kinds of things you really enjoy together, even (and especially) if she enjoys some of them more than you. You know, I tried to get our longtime housekeeper Vicki to hold off on Social Security until she was 70 (she took it at 62) and accept as a final token of appreciation from us an annuity rather than a lump sum of cash (you could get a decent implied return with a Vanguard annuity at that time). She ignored my advice and was proved right to do so. Even though her mother lived to 93, Vicki died suddenly of a heart attack before her 70th birthday -- I was the last family member to spend time with her, puttering around in the yard doing little tasks. She won the bet. She's also an important example. It's good to think of the full range of possibilities and spend enough on things the two of you really like in case one of you says Oops, and pitches forward into your dinner plate.

I have to think about cars. The thing about my life is that the cost of it is relatively low because a good wife and the social interactions and small daily accomplishments of my work sort of do it for me. I can't think of anything more I want. My wife is determined to reciprocate my buying her a nice car, however -- my Honda is an embarrassment to her -- and you have nudged me into a different kind of awareness. I may submit to a better car.

So be good to your wife. I can see that you really care about her. Figure what things really make her happy, and pay what those things cost. Don't worry too much about the future. It will come at us like a left hook anyway. The biggest future threats are probably things you and I have never even thought about.

A Final Note On Return Expectations: What The Trees Know

Financial folks used to say that bond people were smart and stock people not so much. The last few years may have called this into question (although I am always interested in what a few guys like Gundlach are thinking). Trees, however, may be the new bonds. When it comes to return expectations, trees may be the new smart folks.

Here's my thinking on trees. They work night and day building value at a fairly regular and predictable rate. (They also serve the planet by sequestering carbon, by the way.) They have certain predicted end points for harvest -- about 15 years for an early cut or thinning on my pine trees, about 25-30 years for a full-growth cut. The ordinary variables include timber prices at the end point and drought. The drastic variables include fire, hurricanes, or a major assault of pine beetles.

Trees thus share some qualities with stocks, but are generally less volatile. They are what bonds used to be. Tree investors tend to have a steady world view, a cool way of looking at risks, and a rational approach. Tree experts also tend to dress in shabby outdoorsy clothes, but don't let this fool you. They are a bunch of very savvy country boys (and girls).

Trees as an investment strike most people as boring. That's probably a good quality in an investment portfolio. Anyway, it makes trees a good standard for growth in value in other areas. My forestry advisor starts with 7% (nominal) as his return bogey for DCF or IRR calculations. This means that 7% nominal is something like the 30-year hurdle against which to define the competing investment universe when thinking about the value of trees. For what it's worth, this is a major input to my thinking about 30-year returns in all areas.

Right now, expected timber returns may be a bit higher than the rest of the investment universe simply because they are boring, long term, and require knowledge and attention that most people don't want to bother with. My son and I are very interested in them. On the other hand, the rest of the investing universe, the part that is interesting, sexy, and volatile on a day-to-day basis may not quite get you that 7% nominal return.

Well, that's about what I know on the subject of return assumptions for retirement investing, or more precisely, an honest summation of what I don't know. I must thank my fine son for raising a good question and engaging in a good exchange about it. He brings a sharp mind and good judgment to the table. All that I bring is 25 more years of experience watching the ever fascinating drama of human history.

Thanks for taking the time to read this piece. I hope it raises questions to explore and prompts useful thinking about living in the present while planning for retirement.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.