September 10, 2012 Comments

Not surprisingly, markets today gave back some of the big gains from last week.

Apparently the big item this week is an expectation that the FED will announce more “easing” on Thursday. If the FED does not come through then I suppose markets would drop somewhat on Thursday and maybe rise somewhat if it is announced. But all of that is just short-term noise in any event. What really counts is longer term earnings and growth and dividends.

I am thinking about doing some analysis about the viability (or possible lack thereof) of retirement savings these days.

The historic assumption was that one could invest say 10% of earnings over the working years and it would grow after inflation at at least 5% per year. The result was that it was possible to amass enough wealth to retire on by age 65 or even as young as 55 and the investment would provide a comfortable living on top of things like the old age pension (or Social Security for Americans).

Today the real return yield on government bonds is a meager 0.5%.

Imagine if today’s fears come true and people basically make nothing on their investments after inflation and after money management costs. (And if you want to guarantee this is the case, and you are ready for retirement just take all your money and buy real return bonds at 0.5% and pay a fund manager 0.5% to do it for you.)

If zero real return is expected (or locked in) and you wanted to retire at age 60 and let’s say draw out $40,000 per year and adjusted up for inflation each year (assume you have no company pension and so $40,000 may be needed on top of the government plan just to enjoy a good retirement with some travel). And imagine you plan to have enough money to reach age 90, so 30 years retired.

In the case of making no money on investment other than inflation you are going to need a starting pot of 30 years times $40,000 or $1.2 million.

And let’s say you are age 30 today and you are going to save that $1.2 million (in today’s money) over the next 30 years. And let’s say that again you are not going to make any return on your money except enough to keep up with inflation and to cover investment costs. Well laugh (or cry) out loud you would have to start saving $40,000 per year (and adjust that up for inflation each year). And that is completely and totally out of reach for probably well over 99% of people.

The conclusion from all this is that if it were the case that people can’t make any positive real return on their investments then the whole notion of saving for a long retirement completely falls apart.

I will do some calculations but I am sure that it will show that a reasonable scenario of saving for retirement requires investment to earn at least 4% or more in real after inflation returns. And it all works out better and better as the real return goes up.

Today’s real return on government bonds of 0.5% simply makes no sense. At that rate people will basically stop saving and have to plan to work (much) longer and have (much) shorter retirements.

My belief is that the real returns we can expect are in fact a lot higher than recent low levels. Just because markets have returned little in the past dozen years does not mean the same will be true of the next 10 or 30 or 60 years. Just as the high returns of the 80’s and 90’s were an aberration so too are the low returns of the 2000’s to date.