Thursday, October 28, 2010

Gloom and Doom: Retirement Disaster Ahead

The point of the following article is to show we aren't saving enough, but there are more interesting things to deduct from it too, I'll sum a bit after a brief quote:
Warning: Retirement Disaster Ahead
Don't let the rally in the stock and bond markets fool you. Many Americans are still hurtling toward a retirement disaster. Few realize it. Even many of those running the big pension funds don't know.

That's the conclusion of John West and Rob Arnott at Research Affiliates, an investment management firm, in Newport Beach, Calif. In their latest report, "Hope Is Not A Strategy," they have some numbers to back it up.

"I worry a lot about people reaching their golden years and discovering, 'Oh, I should've saved more,' and 'Oh, I don't qualify for Social Security anymore because it's means tested,'" says Mr. Arnott, a widely respected market strategist. "We're headed for a retirement train wreck," he adds, "and it's going to get really ugly over the next 15 years."

Alarmist? Perhaps. But follow the math.

The returns you will get from your stock funds can only come from four things, they note: dividends, earnings growth, inflation and changes in valuation.

The meat of the article is at the part following were I stopped quoting, specifically:
* Low average dividends from stocks
* Inflation implication for stocks prices isn't promising (those who believe hyper inflation is coming will disagree)
* Market average valuation seems overpriced in P/E terms, unlike 70-s and 30-s. (Suggesting market unlikely to rally higher without proven growth)
* Low bond yields suggest very mild long term returns on bond investments (yet the risks aren't priced in due to government intervention)

- All of the items in the brackets are my addition.

So an investor with 60% of his portfolio in stocks and 40% in bonds, a standard, if conservative, allocation, can expect a weighted average return from here of only about 4.1%.

To put this in context, they notice that the typical big pension fund is still expecting to earn about 7% to 8% a year.

When you strip out 2% inflation, that means pension fund managers are expecting 5-6% percent a year in real, inflation-adjusted terms.

But by Mr. West and Mr. Arnott's numbers, investors can only expect about 2.1%.

Suggested lesson:
Bottom line? Neither pension funds nor private investors seem to have fully absorbed the grim lessons of the past decade. Returns are going to be much lower. People need to save more, much more, for their retirement. If the market rally this year has given them false hope, it will have turned out to be a curse more than a blessing.

Interesting reading.

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