# September 11, 2012 Comments

It was a decent day on the markets with the Dow up a half percent although Toronto was flat.

The most notable winner among our stocks was Bank of America up 5.2%. This seemed to on talk that it would start to grow its loan base now that it had jettisoned some other assets and gotten its capital ratios to an acceptable level.

**Pension Math:**

Yesterday I discussed the case where an investor was going to earn a zero real return on investments (and this is about what is available in real return bonds (0.5% before investment costs) and in probably in 30-year government bonds that pay 2.4% or so before inflation). In this case if the investor wanted to fund a $40,000 per year retirement for 30 years in real after inflation dollars then he or she was going to have to save $40,000 per year (and adjusted up for inflation each year) and do this for 30 years in order to fund that retirement.

This is actually what an investor who goes 100% government bonds appears to be facing today if interest rates and especially real return rates remain as is. My conclusion is that young people looking at that would say “forget it”. It shows that a retirement period as long as the savings period is just not feasible, and far from it if real returns will be 0% (which they are for bonds and which some suspect they will be for stocks). And let’s face it starting the savings much before age 30 is not a feasible answer either in most cases. The only solution here would be to plan to work basically forever. Or to find a way to make more than that 0% real return.

I have done the calculations and as I suspected it takes a real return of about 4% to fund a 30-year retirement in 30 years of saving.

It turns out if you save $12,400 per year for 30 years (say 12.4% of a $100k salary) and you make a 4% real return then you can fund a $40,000 per year retirement for 30 years. That’s a stiff savings rate but at least within the realm of the possible.

If you can get 5% real returns then $9400 per year will do, or 9.4% of a $100k salary.

(If the salary is $50k per year then you can reach 40% of that or a $20k per year pension with that same 9.4% savings rate assuming the 5% real return.)

So basically, the math shows you need at least 4% real returns to fund a retirement of at least 40% of your salary assuming 30 years to save and 30 years retired.

This 4% real return used to be accepted as a reasonable (even minimum) real return to expect. In fact you could have locked in over 4% on long-term real return bonds back in the 90’s.

While many doubt it, I believe that the real return from stocks is likely to average at least 4% per year over a period of many years. That would make funding a retirement with stock investments feasible by saving 10 to 12% of wages. And many government and corporate pension plans are closer to contributions of 15% with say 7.5% each from employer and employee).

Current bond yields are simply too low to fund a retirement at any kind of reasonable savings rate.

I believe current long-term bond rates represent some kind of break-down in the financial markets. It simply does not makes sense that the cost of borrowing (and therefore the return available on savings) is at historic lows at a time when debts are so high. Between governments trying to push rates down and institutional bond investors being so stupid as to invest a dime at these low rates, interest rates are unsustainably low. It will not last. I would avoid long term bonds and wait for the inevitable increase in interest rates. Basically I am advocating that in our capacity as lenders we go on strike and we refuse to lend for long terms at rates that are totally inadequate.

I would (and do) invest in some combination of equities and cash and would (and do) avoid long-term bonds.

For more detailed reason why long term bonds should be avoided see our newer article on that topic (with some edits over the past few days adding in words from Buffett about how attractive bonds are (not) at very low interest rates)