Baby Boomers Beware: Low Returns Ahead

The following is a summary of our recent Lifetime Income Series podcast, which can be listened to on our site here or on iTunes here.

Retirement planners often assume rates of return on clients’ portfolios between 6 and 7 percent right now. This time on Financial Sense Lifetime Income Series, we look at why this isn’t likely in our present situation, and what investors can do to protect themselves.

Retirees Face Difficult Challenges

We’re beginning to see the largest generation in US history start to retire and the next 20 years are likely to be high risk for Baby Boomers.

“There are $10 trillion in retirement assets and, in the next decade, 60 million boomers age 70 and a half will have to draw from those IRA and 401(k) accounts,” said Jim Puplava, founder and president of PFS Group.

This is significant because Boomers are entering retirement during a period of expensive stock market valuations and very low interest rates.

Couple that with the fact that life expectancy is going up, and Boomers may face the prospect of living longer with lower income.

Interest Rates Are Very Low But Going Up

Right now, we’re living in a period with the lowest interest rates in recorded history. That’s beginning to change, but this has been a horrible time to earn interest.

“If you take a look at recorded history, going back 5,000 years, interest rates have averaged between 6 and 10 percent,” Puplava said.

Right now, we’re nowhere near this average.


Source: Business Insider

The other issue is, as people approach retirement, their portfolios tend to get more conservative. We’ve seen dividend distribution from bond funds, mutual funds, and bond ETFs consistently fall each year, meaning income is reduced in retirement.

“Boomers are retiring and living through something that, quite honestly, we’ve never seen in history,” Puplava said.

Think of it this way: In 1990, if you had 0,000 to invest, a 10-year Treasury note yielding 8% could have produced an income of ,000 each year.

In the year 2000, that same 0,000 would have produced ,000 of income at 6% on a 10-year. As of 2017, 0,000 would only produce ,400 of income at 2.4% on a 10-year, Puplava noted.

“That just goes to show you how low we have gotten,” Puplava said. “I’ve never seen anything like this.”

Bonds and Stocks Are Risky Going Forward

If interest rates rise, which they’re likely to do from these historically low levels, investors could lose money on bonds if sold prior to maturity.

“You can lose a lot of money in bond bear markets,” Puplava said. “The difference between bond bear markets (and stock markets)—when we think of stocks, we think in terms of 1 to 2 years. The thing about bond bear markets, they’re not 1 to 2 years—they’re 2 to 3 or more decades.”

This is one reason Puplava prefers to keep investors’ assets in single bonds.

“We don’t use bond funds, and we don’t use bond ETFs,” he said. “We use individual bonds—if I own a 1-year, 2-year or 3-year bond, I’m not worried about interest rates going up.”

By keeping duration exposure limited, investors can roll principal into new bonds.

“Boomers are going to live out their entire retirement years through a major bond bear market,” Puplava said.

We’re also starting with a stock market that has a much higher price-to-earnings ratio, meaning that you’re having to pay as an investor more money to buy a dollar’s worth of earnings.

When the Case/Shiller PE is at historical records, it implies lower returns going forward.

Traditional 60/40 Retirement Plan Splits May Fail

The reality is, a lot of financial plans, financial planning software, and pension plans have unrealistic assumptions built in, Puplava stated.

Studies have found that the average long-term expected return of 6.2 percent is too high. Also, inflation expectations are too low, and the inflation rate eats away at the expected return rate as well.

Many investors believe assuming a lower rate of return, say around 5 percent, is adequate.

“That seems reasonable and conservative,” Puplava said. “Folks, it isn’t. If you invested in a balanced mutual fund or a balanced ETF, chances are you’re looking at that 60/40 split. Now, brace yourself, according to a recent Research Affiliates report, the ubiquitous 60/40 portfolio has a 0 percent probability of achieving a 5 percent return or greater in the next 10 years.”

These high returns of the past come at a cost. Anytime we see a high period of return, we tend to see lower returns in the future.

Where to From Here?

There are two implications: retirees are going to work longer or have a lower standard of living.

For younger folks, the best thing to do is plan to put away more money and spend less.

For those heading into or close to retirement, they’re probably going to end up working longer or working part-time to cover shortfalls.

“High returns of one era make it more likely we're going to experience lower returns in the next era,” Puplava said. “And that’s where we find ourselves today.”

For our related case study, see pdf here or follow along with the slides below.

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