“New Normal” math: How your investing plans must change

by Pop on July 23, 2010

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So, when can we start calling it the “old normal”?

Stocks have gone nowhere in ten years. Not even dividends have made it better. Sure, you might have had a bit of a gain if you stuck your money in emerging markets at the right time or gold or any of the other asset classes that turned slightly positive. But on the whole, buy-and-hold investors had it pretty crummy.

And yet, we still get this from Dave Ramsey (hat tip to All Financial Matters for noting the clip). On slide 12 of an otherwise smart little video on not rushing out to buy a new car, Ramsey throws out this line (paraphrased): “But instead of spending that money, you’ve invested it in a mutual fund earning the average stock market return of 12%.” Bwahahaha.

A 12 percent stock market return is so 1998. We know now that 12% is wildly optimistic. Eight percent might even be optimistic. What’s more reasonable? Take this sobering assessment from Bill Gross in Money Magazine this month: “Instead of 10% returns for stocks, look for five or so. And instead of the past 20 years’ returns on bonds, which are actually better than stocks — close to double digits — it’s 4% going forward.” Oof.

Gross, and his colleagues at bond investment shop PIMCO, call this low growth period for investments and the U.S. economy the “new normal.” It’s hard to say PIMCO is “talking its book“, because it doesn’t see bonds as faring all that well either.

There seems to be a general consensus that PIMCO is more right than Ramsey is. But I don’t think the implications of changing stocks’ rate of return from 10% to 5% have sunk in. We acknowledge that stock returns will be poor, and yet all of our retirement advice—save 10% of your income…withdraw 4% in retirement—stays the same. So, for your viewing pleasure, here are a couple math problems.

How your savings rate changes.

Scenario: 45-year old making $90,000 per year. Plans to retire at 65. Holds a $200,000 portfolio.

In real life, this guy would slowly shift his money from stocks to bonds, but to keep it simple, let’s just assume he puts it all in stocks. Since we’re using an “average” rate of return, rather than the volatile real-life returns he’d really get, we’re being generous.

Old math: If he saves 10% of his income per year (pretty standard advice), his portfolio grows to $1.86 million. Using the flawed-but-ubiquitous 4% rule, in his first year of retirement, he could afford to withdraw $74,400. Combined with Social Security, that’s not a bad income.

New math: But what if his portfolio only returns 5% per year, as Gross predicts? If he held steadfastly to saving 10% per year, at age 65, he’d have $828,253. That would leave him with an income of just over $33,000 plus Social Security. That’s less than half of the old math scenario.

Unacceptable, right? So what does he have to save instead? Please don’t cry. That 45-year old, trying to achieve a $1.86 million portfolio with only a 5% return, would have to save forty-four percent of his salary per year. If he was willing to work until age 70 instead, he could save 28%. But still, that’s a huge difference. I used the simple calculator here for all the calculations.

How your withdrawal rate changes

Oh, and about that 4% withdrawal rate. I’ve written before about how writers and planners twisted the findings of a few Trinity University professors into a mantra that at least one of the professors doesn’t believe. But the 4% rule gets even more off base when you start to assume stocks grow more slowly than they have in the past.

Why? Well the Trinity guys used stock returns between 1926 and 1997 to inform their results. That’s a time period that saw the United States rise from upstart nation to global superpower. Do we really think the pattern of returns we saw then is going to repeat itself going forward? As financial columnist-turned-money manager Scott Burns notes, when you start to factor in the sad truths of modernity—like lower interest rates, lower dividends, and, yes, lower stock returns—the rules developed by probability studies that were done just a couple decades ago don’t seem to apply any more.

Shutting down in the face of uncertainty.

I don’t save 44% for retirement. Not close. I don’t save 28% for retirement. Still not close. In the face of numbers like that, it’s no wonder that we’d rather hear about magical 12% rates of return on stocks that no one believes anymore.

The good news is that if you’re young, you have time. And while you can’t control what your investments do, you have a couple other dials you can turn to give yourself a chance to retire. One, is the aforementioned savings rate, no doubt the most painful of the bunch.

Option number two: Retire later. You’re likely going to live to an age older than your parents anyway, and I’m sure you’ve had it in the back of your mind that it was never reasonable to work 40 years and then have a 40-year retirement anyway.

And option number three—the most fun option—is to earn more money. With a higher salary, you can save 28% but maintain the standard of living you had when you were earning less and saving 10%. Unless you have a defined benefit pension—and few private sector employees do anymore—this is the only truly guaranteed way to have a reasonable shot at early retirement.

Just a small prediction: You’re going to be hearing a lot about earning more from me and personal finance authors in the coming years. Because we’re finally starting to realize that investing well and being frugal just isn’t going to be enough anymore.


{ 11 comments… read them below or add one }

Jacq @ Single Mom Rich Mom July 23, 2010 at 11:54 am

I think your prediction is totally correct that there will be much more written on how to earn more. I also predict that there’s going to be a very large number of people that will have to go back to work part-time. I’m curious to see the impact on the housing markets too – Seniors won’t need the McMansions – who will afford them? Time to invest in a company that spits out cheap park model homes maybe.

I’m hedging things by assuming that I will have to work part-time just so I don’t get my hopes up and be as naive as DR’s fans. My firecalc and my own spreadsheet numbers say I don’t have to, but like you, I don’t know what to believe anymore and would rather prepare for worst case scenario. Maybe I won’t have to and that’s fine but I want to be mentally prepared. :-) Or I’ll find something I just like doing a bit, like working at a bookstore or something a few hours a week.

Re Ramsey – I’ve never heard his show, never read his books, but have placed one on hold at the library because I’m curious what the fascination is about.

Oh, and another downer – I can’t believe that the US government won’t be having to raise taxes in the future to pay that debt, fund retirements, pay for all those people who are sick because of lifestyle choices but are kept alive through the miracles of modern medicine and can’t work – so people should probably be factoring that in somewhere too. So hurry and make your extra money now!

Rob Bennett July 23, 2010 at 3:13 pm

My view is that you are making excuses for a failed model, Pop.

Stocks are providing just the returns we should have expected given where prices were in the late 1990s. We were borrowing from future investors when we pumped prices up so insanely. The future investors we borrowed from are now today’s investors — Us!

Buy-and-Hold is the investing realm’s equivalent of living it up for a few years by taking on huge amounts of credit-card debt. It sounds groovy until the time comes when you have to pay the bill — with interest!

The day we start talking openly about all this is the day that everyone’s spirits will start to lift. We can make the money back. It’s the shame that is killing us. We need to get our minds off the past and begin looking forward to future triumphs. We do that by coming to closure re the foolish mistakes we made in earlier days.


Pop July 23, 2010 at 6:53 pm

I disagree that I’m “making excuses”. I’m well aware that stock returns in the last decade or so have been poor, and that a reasonable person could argue that valuations could have predicted it. However, people have got to do something with their money, and in the absence of a stock or bond market that’s likely to give good returns, it seems reasonable for people to need to retire later, save more, or earn more.

Pop July 23, 2010 at 6:55 pm

Yeah, taxes aren’t something I even mentioned here. To pay the debt, we need to inflate our way out of it, cut spending, raise taxes, or pray that the economy picks up. It seems the Feds were praying for the last solution, and now are coming to the realization that something else has to give.

Rob Bennett July 24, 2010 at 6:51 am

in the absence of a stock or bond market that’s likely to give good returns

It’s not my intent to be argumentative, Pop. You’re trying harder than just about anybody else out there. I applaud you for it.

There’s nothing wrong with the idea of people retiring later or saving more or earning more. But giving up on the stock market is the worst thing we could all do. The next stage in this cycle is for stock prices to drop to one-half of fair value as a result of us all giving up on stocks. It would be just as insane for us to let that happen as it was for us to let stock prices rise to three times fair value. If we let that happen, it would mean the loss of trillions more in middle-class wealth. It is easy to see how that would mean the Second Great Depression. Where are we all then?

The problem is not with the stocks. The problem is with the people buying the stocks. None of us really know what we are doing today. Our understanding is at a primitive level. Let’s take that as a challenge to learn, to do better in the future.

We need to do the things you are talking about. Those are positives. But we need not to give up on stocks. Learning how to invest in stocks could be a huge help to us all. I think we need to make that part of the solution here too.


Craig July 24, 2010 at 10:44 am

@Rob I’m not sure Pop was saying to give up on stocks. I think he’s just pointing out that stocks and bonds won’t be the golden cow we’ve expected them to be . I recall a few years ago Warren Buffett saying that he didn’t expect stocks returns like we’ve seen in the past.

Even if stocks only return 5% it could still be one of the better investments out there. But we can’t relay only on investing anymore. As you mention Rob, we need to learn more and educate ourselves. In doing this we can find ways to make ourselves more valuable and earn more money.

I hope these estimates are wrong but I think it would be prudent to expect them to be correct.

Rob Bennett July 25, 2010 at 1:48 pm

[i]stocks and bonds won’t be the golden cow we’ve expected them to be [/i]

I don’t want to speak for Pop, Craig, but my sense is that he is saying pretty much what you are saying he is saying. He is in company with a lot of smart people saying that (as are you).

I am saying something different. I agree that stocks are not a good deal today; prices are still too high. But [i] in relative terms[/i] stocks offer a better long-term value proposition today than they have at any time dating back to 1995.

The deal gets better each time prices fall a little more. When prices get to one-half fair value (as they in all likelihood will within the next few years — we have never not seen this happen in the years following an out-of-control bull) stocks will be offering a likely annualized return of 15 percent real. We should today be helping people to learn how to recognize when stocks offer a strong value proposition so that they will be ready to pounce when a great value proposition appears before them, not playing up to the fears over stocks that people are beginning to feel all on their own.

This is my view of things, Craig. I am not God, I could be wrong. My view is a minority view. Lots of smart people think I am wrong. But this is my sincere view and, if I do not express it here, I have a strong sense that there might not be anyone else who does so. So I feel obligated to say what I believe.

I hope that we all can remain friends despite any disagreements we have on how stock investing works. I learn from you and from Pop and from all others who post here. I like to think that there might be a time when someone will read some of my words and perhaps learn something from them. I know that that will never happen unless I continue posting what I believe. So I make an effort to do that even though I sometimes get the feeling that some would prefer that I not do so (I don’t mean anyone here, but I have certainly had that feeling at other places).

We’re all in this together. We’re all trying to learn. We all learn from those who disagree with us. So we all need to say what we truly believe, to say we agree with others when we really do agree and to try to articulate our differences politely and warmly and clearly when significant differences of viewpoint evidence themselves.

My view is that we have been living through the darkest days to own stocks ever in our history from 1996 forward. But things are now looking a little better. Within a few years, I think stocks may once again be available at prices that will make them a far better long-term deal than any of the super-safe asset classes (this hasn’t been so for nearly 15 years now!). I don’t want anyone to miss out on the opportunities that may be coming because I failed to articulate the case for why stocks are beginning to look better rather than worse.


Brad Robles July 26, 2010 at 9:21 am

Why is Rob Bennett still allowed to troll this board?

He adds nothing, and is argumentative, but without any reasoning or facts to support his own contrary positions. The man is a scourge on the internet.

Rob Bennett July 26, 2010 at 2:39 pm



Ken July 26, 2010 at 3:08 pm

I agree with a lot of your points. Conventional wisdom must change regarding what successful investing is in 2010. Returns will be lower which means investing more to get the amount you need for retirement. I guess downsizing retirement expectations is also an option. I’m with you on the need to earn more for the retirement that is 10-20 years away. Good post.

K Smith July 26, 2010 at 11:28 pm

I believe there is a great deal more to modern retirement planning than earning more and lowering our expectations for market returns.

Our government has promised services to its citizens that are beyond the ability of our economy to generate the tax revenue necessary to pay for them. We are just like a giant General Motors. We have promised more in benefits that we are able to pay. The numbers just don’t add up. 2+2 will never equal 5.

There are 4 possible economic outcomes.

1. Catastrophic deflation. This means a severely tanking stock market as debt bubbles continue to deflate and cash moves to pay down both public and private debt.

2. “Soft” deflation. This means a declining stock market as holders of cash continue to pay down debt despite the Fed’s likely efforts to goose spending.

3. A flat recovery. The Fed will likely attempt to spur a recovery thru inflation, which will kill the dollar and the bond market. This means a rising stock market as those who hold cash move it into the stock market.

4. A weak recovery. This means anemic stock market performance.

The key to investing for retirement is predicting the behavior of holders of cash. Predicting the Fed/Treasury response and understanding its likely impact will lead to the best decisions on how to invest for retirement – and whether to invest in the stock market at all.

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