Retirement’s gonna cost more, and advisors need to prepare their clients—not just by warning them, but by changing the way they plan for client portfolios.

That’s the assertion in “Planning for a More Expensive Retirement,” a study in the Journal of Financial Planning, which warns readers that recent studies are suggesting that the demand for stocks since 1980 has pushed down returns “below their historical average,” and that bonds are also providing yields that are considerably below historical averages.

When coupled with the rise in longevity, the study says, the result is a doubling of “the cost of funding a real dollar of income in retirement since 1980 for a 65-year-old retiree.”

Since most planning is based on historical averages, if those historical averages fail to materialize in the future, projections for a portfolio’s performance are likely to be considerably off. Clients are likely to be left high and dry if assets don’t provide returns as projected—something advisors need to be aware of.

The study’s authors write that “[r]esults from a life cycle planning model showed that savings rates would need to rise sharply for households hoping to maintain the same standard of living in retirement if real asset returns are low”; a continued low-return environment will negatively impact client spending “throughout their life cycle.”

And that puts the onus on advisors “to modify expected returns in planning software to provide clients with more realistic projections on meeting long-term spending goals.”

The study, which “provides the numbers needed to re-adjust the retirement expectations,” drives home the point that it’s not just the clients’ expectations that need to be adjusted but also the advisors’. In evaluating “how lower expected returns affect optimal saving and spending during working years, retirement replacement rates, retirement lifestyles, and the cost of bequests,” the study challenges many of the accepted tenets of retirement planning.

While an earlier study estimated that “the 10-year return on a bond portfolio can be predicted with 92 percent accuracy based on beginning-of-period interest rates,” the study says the same is far from true for stocks.

The return over a 10-year horizon for a stock portfolio “can be predicted with only 27 percent accuracy by using beginning-of-period valuations (10-year Shiller price/earnings ratio).” And that can lead advisors to “assume historical returns.”

Then there’s the consideration of the kind of return to be expected “from risky assets in the 21^st century.”

While the total market capitalization of U.S. stocks increased from 50 percent of gross domestic product in 1980 to 141 percent in 2007, the study says, by October of 2016, the ratio was 120 percent—so, even though stock prices came close to tripling, corporate profitability lagged far behind.

Therefore, the study reports, in 2007 investors had to shell out 266 percent more for each dollar of corporate earnings than they did in 1980.

Investors might reap these profits through dividends, although the study points out that the dividend yield is less than half its historical average of 4.4 percent, or they can be reinvested to provide growth.

Because expected stock returns are a function of the risk-free rate plus the risk premium, according to the capital asset pricing model, the study says, and because nominal returns on equities in the future are expected to be “lower than the arithmetic historical average,…. [t]he only returns an investor can hope to receive from equity ownership are either future dividend payments or growth in future earnings.”

Because of that, the authors write, “it is sensible to see the equity premium as a function of stock price and a firm’s ability to pay money back to investors.”

Since stock prices are rising faster than growth in dividends or earnings—unlike the way stocks behaved between 1875–1950, when stock prices “tended to rise in accordance with growth in dividends (or earnings),” investors—and advisors—have grown accustomed to the way stocks have behaved recently, with prices rising more rapidly than firm earnings. (During the period 1951–2000, the study adds, stock price growth was 5.89 times greater than dividend growth.)

And because both clients and their advisors are used to this recent “excess capital gain,” the authors write that stock price increases without corresponding increases in earnings “may have created an expectation of future returns that is inconsistent with the actual returns that stocks can provide at their 2016 valuations. Stocks either need to fall significantly in value (by more than half) in order to maintain the historical equity premium, or investors will need to get used to a lower return on equity investments.”

Clients are also looking at advisors’ fees and perhaps thinking they’re getting less for the money, and 1990 figures indicate that Federal Reserve data on average yield show a client working with an adviser charging a 1 percent fee on assets under management would have paid 12.2 cents for each dollar of income on 10-year Treasury bonds.

But at a 2.36 percent yield, the study says, a client pays an adviser 42.4 cents for each dollar of bond income. Also, in 1980, a client paid 8.85 cents in adviser fees for each dollar of corporate earnings from stock ownership, but in late 2016 each of those dollars in earnings cost the client 27 cents.

Then there’s the issue of client longevity. In 2016 it became clear that the combination of lower asset returns and long retirements made the year the most costly “since calculations began in 1980,” and future planning “would require increased savings, reduced consumption in retirement, a delayed retirement, or some combination of these to achieve a successful retirement.”

This is particularly important since the implications of a low-return environment coupled with inflation and investment expenses could result in a future 0–2 percent real portfolio return. And that low-return environment will also substantially reduce the amount that savings will provide in income during retirement.

Not only will this affect how much households have to live on during retirement—possibly compelling a reduced spending level, depending on the level of assets the client has and whether the level of spending falls upon retirement—it will also affect any plans clients may have to leave a legacy.

The authors write, “Households will need to accumulate more wealth to maintain even their lower level of lifetime spending in retirement, assuming the low-return environment persists. However, they will need to have a higher savings goal amount in order to sustain that lower level of retirement spending—particularly if they hope to leave a legacy.”

Reiterating the need for advisors to plan for a more expensive retirement, the authors warn, “The price of a dollar of safe income for a client retiring in 2016 is nearly 50 percent higher than it was for a client retiring in the year 2000 because of increases in longevity and declines in real bond interest rates.”

Instant Insights /

Advisors, clients face uncertainty on costlier retirement

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