CFA material: shedding light on the ave. American’s rocky retirement future


I’ve started to notice a disjoint between my generation (read: me) and older generations regarding what should pass as a reasonable rate of return to expect on a retirement portfolio projected into the future. The older generation appears to be much more optimistic than myself. Many of their cohort have no qualms about applying hefty annualized growth rates to their portfolios. Granted, this observation is anecdotal, though I was reminded of the issue while reading through an example in one of the Schweser books:

Assume a 35yr-old investor wants to retire in 25yrs
She expects to earn 12.5% on the portfolio prior to retirement, and 10% thereafter
She wants to withdraw $25k per year for 30 years after retiring

So, how much does she need to deposit in each of the 25 years in order to secure that payment stream? A simple calculation shows that depositing approx. $1,800/yr in the 25 years preceding retirement should allow her to secure the desired income. Suppose her HH income hovers around an ave. of 60k after taxes (generous for the ave. American HH), 1.8k/yr would amount to about 3% of the HH’s ave. annual after tax income over the accumulation period.

Now imagine we change a couple of assumptions, namely we apply a pre-retirement growth rate of 8% and a post-retirement growth rate of 5% to the portfolio (because we may or may not ever see a spike in the 10yr like the one experienced between 1979-1985), change the desired withdrawal to 35k (predicated on the expectation that food and medical care will not get cheaper), and finally we increase the ave. after tax HH income over the period to 70k (due to a 2nd technological revolution, etc.).

How much does she/the HH need to sock away annually in order to meet the desired withdrawal? Approx. 7.7k, which amounts to about 11% of the HH’s ave. annual after tax income over the accumulation period.

The difference between deferring 3% of today’s income to live comfortably tomorrow is significantly different than deferring 11% for the same outcome. At 11% you start eating into your present quality of life in a meaningful way. I get the sense that the generation I will age with is hopelessly unaware, but again, my observations are mostly based on anecdotal information gleaned from identifying cases-in-point. I’ve yet to sit down with the data, and there are too many exogenous factors that could change the underlying assumptions and thus generate a more positive outlook. For instance, maybe technological revolution part II propels the ave. American to work well into the 70’s, thereby prolonging the pre-retirement cash-flow stream and allowing the base to compound longer. This seems more likely than an overhaul of government sponsored entitlement programs to support pensioners living into their 80’s, or asset growth rates that would secure annualized portfolio returns in the low-teens for the ave. American –high-net worth clients with access to skilled investors, yes not unlikely; but for the ave. HH with a takeaway in the mid 60k’s, not so much.

And it doesn’t help that stay-at-home moms are taking out home-equity loans to parade larger racks to soccer practice.

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