planning toward retirement

palomalouMay 2, 2009

Among the things I've been doing to prepare for retirement in approximately ten years is completing retirement calculators. One question they all ask is how much rate of return you expect to earn on your investments. Is there any kind of ballpark reasonable % to guess? I've been going with 3% on the theory that it's best to be conservative--but I don't even know if that's conservative! Any expert, please speak up. Thanks!

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The expected rate of return and the expected rate of inflation are the two bugaboos of these financial planning software kits. The "expected" rate of return depends on your asset allocation -- percent in stocks, bonds and cash equivalents, is of course an average over up to 20 years, but the yearly rate will fluctuate.

If you invest very conservatively (very little or no stocks and mostly in bonds and case equivalents) your rate of return will be low, you will have less volatility from year to year, but you may run out of money if your nestegg's return does not exceed inflation rate. So you need stocks because they appreciate more than inflation ON AVERAGE OVER MANY YEARS -- the last few years are of course an exception.

Another benchmark the gurus talk about is that you should spend no more than 4% of your nestegg the first year of retirement, and then give yourself a small "raise" of, say, 3% per year to compensate for inflation. That's supposed to be a "self-sustaining" spending rate, one that will not run out of money when you're too old to do anything about it. Again, the assumption is that your asset allocation is right. AND THIS IS MOST IMPORTANT: How is the economy when you retire? If it's on the upswing, okay. But if your stocks lose money just when you retire, you're in trouble, and the 4% rule won't work, and you could run out of money after 15 years.

To review: the big unknowns are: inflation rate; asset allocation; state of the economy when you retire. You can control asset allocation, getting more and more conservative as you approach retirement, but still keep some money in stocks. How much? That depends on how badly you need your nestegg and how generous you pensions are. Your retirement software, if it's worth anything, should help you decide what asset allocation makes sense for you. The other thing you can control (and should) is the expense of investing. In this respect, I'm a big fan of index mutual funds. They are the cheapest and they take the guesswork out of investing.

    Bookmark   May 2, 2009 at 5:08PM
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