So far, the 21st century has turned much of the traditional wisdom regarding retirement planning upside down. To respond, Americans need to revamp several of the assumptions that go into figuring out how much to save for retirement.
Here are five components of retirement planning that are very different today than they were at the end of the 20th century:
1. Stock returns
Retirement planners used to routinely use a 10 percent annual return assumptions for stocks, because history had indicated that was about what stocks averaged over the long run. Expectations were raised even higher during the late 1990s, when stocks had a multi-year period of exceptional returns.
Over the last 14 calendar years though, stock prices have gained less than 2 percent a year. This is a challenge to retirement planning in two ways. First, those fourteen years have left a sizable gap in the growth investors assumed their portfolios would have by now. Second, it raises the strong possibility that in an era of slow global growth, the stock market can no longer be counted on to regularly produce 10 percent annual returns.
2. Bond returns
Historically, 10-year Treasury bonds have yielded an average of 6.1 percent. That yield made them a perfect complement for stocks in a retirement savings plan, as they gave a portfolio some measure of stability while still producing a solid return.
Today, 10-year Treasury bonds yield less than 3 percent. As much as financial planners rely on historical returns as a guide in making return assumptions, this practice would be misguided with bonds. Not only are yields less than half their normal size, but total returns on bonds over the past 30 years have been boosted by a sustained drop in interest rates that cannot be repeated with rates now so close to zero.
3. Income yield
If bond yields are small, bank rates are microscopic. With savings account interest rates at less than 1 percent, it means people cannot count on living comfortably off income in retirement. It also means that there is a price to be paid any time you move into conservative investments, since you can count on virtually no return from those investments these days.
The one silver lining of the environment of the past 14 years is that inflation has been unusually low. If inflation can remain consistently below the level that was once thought of as normal, it means people may be able to lower their retirement targets. That's just as well, since savings rates and investment returns have not kept up with those targets anyway.
5. Asset allocation
With interest rates so low, people may be forced to rely more heavily on stocks almost by default. In particular, bonds may warrant a reduced role going forward because they do badly in rising interest rate environments. Tilting portfolios toward stocks in favor of bonds is going to require dealing with more erratic returns. That in turn could force people to alter the timing of their retirements.
Ultimately, tweaking investment strategy is only going to be of limited help when returns have been disappointing across all major asset classes. The only real solution is to save more, and for a longer period of time. People who are too slow to adjust to that reality will pay the price in retirement.
The original article: A 21st century guide to retirement planning appeared on Money-Rates.com
3 stocks to own for the rest of your life
As every savvy investor knows, Warren Buffett didn't make billions by betting on half-baked stocks. He isolated his best few ideas, bet big, and rode them to riches, hardly ever selling. You deserve the same. That's why our CEO, legendary investor Tom Gardner, has permitted us to reveal The Motley Fool's 3 Stocks to Own Forever. These picks are free today! Just click here now to uncover the three companies we love.
Additional retirement articles can be found on Money-Rates.com
Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.