A Retirement Crisis Is Looming, and America Isn’t Ready

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Retirees Are Too Optimistic

Retirees often have overly optimistic expectations about their investment returns, expecting much higher rates than historical averages suggest. Recent data from Natixis and Vanguard (NYSE ARCA: VTI) show that many believe their portfolios will significantly outpace inflation, but realistic projections indicate much lower returns. To counter these challenges, retirees should save more, maximize tax-free accounts, consider additional income sources, and adopt a flexible withdrawal rate to ensure financial stability in retirement.

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Transcript:

We've talked a lot about retirement and how to plan, save, and invest accordingly.

One of the things we find is that retirees are too optimistic about their expectations and can get caught unaware.

Now, we recently saw some more data that confirms this from Natixis, Vanguard, and others.

So Austin, could you break down some of this data and what retirees need to know from it?

For investors out there today, it's easy to get obsessed with the spectacular stock market success stories like Nvidia, which of course has beaten inflation and every other stock on earth virtually in the past year by close to 200 percentage points.

But frankly, it's unrealistic to expect a retirement portfolio to do anywhere near that well or to beat inflation by even one tenth of that amount.

Unfortunately, a lot of investors foresee that type of performance.

So 2023, the Natixis survey found that US investors on average believe that their portfolio will outpace inflation by 15.6% annualized over the long term.

Now, let's just be clear, 15.6% returns a year on their own would be absolutely fantastic.

Beating inflation by 15.6 percentage points is absolutely heroic.

We're talking Warren Buffett level returns there.

But in reality, the U.S. stock market has historically beaten inflation by about six percent annually.

And this is according to a database out of Santa Clara University.

So nowadays, even that average is probably too optimistic as we start to see elevated inflation rates.

So persuading investors to be more realistic about how much their portfolio will beat inflation can be challenging.

So financial advisors who should guide realistic retirement planning are also overly optimistic.

That same survey reports that the average advisor expects global stocks to outperform inflation by 9% annually.

So it's fun to be an optimist, but unfortunately, if you're trying to plan for retirement, we think it's a lot better to be a realist.

And historically, that 6.1% average is just too optimistic for the next decade or two because stocks today, frankly, they've got really stretched valuations and inflation is still running well north of 3%.

So eight different valuation indicators used to project the S&P 500's return over the next decade, averaging in inflation-adjusted in a total return of negative 1.9% annually from now until 2035.

Now, that seems like a very precise number. Maybe it's false precision.

I don't know if it's going to beat by half a percent or lose by 2%.

But the point is, we're a world away from beating inflation by 15 percent that many investors hope or the nine percent that many financial advisers hope.

So bonds, unfortunately, are also projected to perform below average, though maybe a little better than stocks.

One projection method uses tips or treasury inflation protected bonds, which have a real yield of only 2%, meaning they're guaranteed to produce a return of 2% annualized above inflation if held to maturity.

But again, still falling well short of many people's expectations for their portfolio here.

So what are people to do?

If it looks like bonds are only going to outperform inflation by 2%, and by this one survey's math, stocks will underperform inflation by almost 2% annually from now until 2035.

What are investors to do?

Well, it's the same advice that we've always given in the past.

Save and invest as much as possible.

If your portfolio is going to be lagging to inflation or even matching inflation, you might just need to plan on saving more for retirement than you had previously budgeted for.

We've talked about a million dollars being the number that many retirees need to feel comfortable about their retirement.

Maybe 1.1 million, 1.2 million becomes the more realistic number going forward.

We also recommend people max out tax-free accounts and employer contributions if they're available to them, because of course that is free money.

If people are physically or mentally able, they might want to consider additional income beyond just social security by taking on a part-time job, investing in real estate or buying more dividend stocks.

And plan on saving, as we have talked about, at least half a million dollars in retirement per individual, over a million dollars for a couple more is obviously better here to try and get above the reality that your portfolio is unlikely to beat inflation by nearly as much as it has in the past.

And more importantly, given how volatile times are, given how stretched valuations are, adopting a flexible 3% to 5% withdrawal rate where you withdraw 3%, 4%, or 5% of your portfolio each year in retirement in reaction to changes in the market in your own situation.

So spend a little bit more on the good times, getting that 5%.

Spend a little bit less on the lean times, get closer to that 3%.

Particularly after a year of poor stock market returns, that will help your portfolio outpace inflation by compounding at a greater rate and leaving more money in your account after a down year so that it can grow and hopefully beat inflation for retirees.

Yeah, it's outstanding advice, Austin.

I know, as you know, everyone wants to believe that we are Warren Buffett.

But study after study has shown that investors tend to actually underperform even indexes like the S&P 500.

And a big part of that is taking money out at the worst times when the market is down, adding to it in turn times of enthusiasm.

So if you're modeling in, if you're looking at getting returns significantly above market averages, just be aware of the history there.

And the advice that you gave around building in more safety is going to really help retirees be able to have a stress-free and enjoyable retirement.

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