When markets are down, you don’t want to look at your 401(k) statement. But with a potential “lost decade” of stock returns looming, you have to at least take a peek, because it’s time to get real about your ability to afford retirement.
Economists often point to the fact that stock markets always eventually go up, but there are times where returns are down or flat. Those periods can last a while, even a decade, as they did from 2000 to 2013.
Your assumptions may be woefully inadequate if the numbers you used to figure out how much you’d eventually need are any older than six months. Even if it hurts, you need to jump online and run the numbers again using a calculator — or consult a financial professional.
3 key numbers to update
The way most people save for retirement is to first come up with a big, round amount that they’ll need, like $1 million, and then calculate backwards to see how much to save today to get there. That entails a few key pieces of information. On the one hand are the big imponderables that are specific to you, such as when you will retire, how long you will live and how much you’ll spend. Then there are the factors you can’t control: how much will your investments grow, what’s the rate of inflation and how much Social Security will pay out.
If you use a retirement calculator, it’ll ask you for a combination of inputs. These are the three key ones that you need to change.
1. Account balance
This will be a reality check, with the S&P 500
SPX,
down 24% year-to-date through Tuesday. But maybe it’s not as bad as you think. If you have some bonds
TMUBMUSD10Y,
or some cash in your accounts, you might not be down as much as Dow Jones Industrial Average
DJIA,
Nasdaq Composite
COMP,
or other major index.
Depending on how much you have saved, you might be surprised that the dollar amount is not that huge.
But you won’t get an accurate take on your future if you don’t start with what this number is today, rather than what that account used to be or what you think it should be.
2. Average rate of return
If you’ve been basing your retirement projections on 7% average returns or some number higher than that for your total portfolio, “I wouldn’t say you’re downright crazy, but, statistically, you’re looking at the top quartile of expected returns,” says Amit Sinha, head of multi-asset design at Voya Investment Management.
He says 5% is closer to reality. That’ll change your numbers, even over relatively short time periods. Say you are 55 and have $100,000 saved for retirement now. The difference over 10 years between those two assumptions is around $34,000.
If you draw that out for a 25-year-old, the difference over 40 years could be nearly $800,000, though perhaps expected returns will eventually reset higher.
For now, experts like Sinha at Voya are calculating their assumptions toward the lower end. “If you look at a balanced portfolio, your fixed income is in the 4 to 6% range; equities are 5 to 7%,” he says.
But remember that’s an average, so half the time the returns will be higher and half the time lower, and what you’re looking for is an end number that will give you a high probability of not running out of money before you die. That means you need to look at the worst-case scenario and make sure that if returns bottom out, you’ll still have enough money.
More: How to turn $30,000 into millions: the power of time beats a lucky stock pick
3. Inflation
Fed chairman Jerome Powell has set his goal for inflation at 2%. That is probably a little too rosy for planning your retirement scenarios right now, given that the headline rate is above 8%.
The good news: you don’t need to go that high for your projections. “Current inflation is not projected to really stick around, so 2.5% is reasonable long-term,” says Wade Pfau, a professor at the American College for Financial Services.
While this seems like a small difference, even a half-percent over the long term can eat into your returns. And that, in turn, makes a big impact on how much you can spend each month when you’re actually retired.
At current rates, the old standby of 4% being a safe withdrawal rate starts to look too high. “I’d generally say 3% is a more appropriate number in the current environment,” says Pfau.
Heed the alarm bells
Your new retirement number may be bleaker than you are used to, so get ready to act. “The shift we see right now requires a change,” says Sinha.
How you’re affected by this depends largely on your age and when you need to start cashing money out to cover your living expenses. You may need to save more, retire later or plan to have less later on. If you’re still working and your time horizon is longer than 10 years, the alarm bells don’t need to go off just yet. You want an accurate picture, but you’ve got time to keep saving and don’t have to change strategy.
But if you’re 55 or older? Sit up and take notice, because a lost decade would put you right on the cusp of retirement. And if you’re older? “It’s that window of 60-70 when what happens in the markets in those years will have the biggest impact,” Pfau says.
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