Brett Arends of the WSJ reports, Warning: Retirement Disaster Ahead:
let the rally in the stock and bond markets fool you. Many Americans
are still hurtling towards a retirement disaster. Few realize it. Even
many of those running the big pension funds don't know.
the conclusion of John West and Rob Arnott at Research Affiliates, an
investment management firm, in Newport Beach, Calif. In their latest
report, "Hope Is Not A Strategy," they have some numbers to back it up.
worry a lot about people reaching their golden years and discovering,
'Oh, I should've saved more,' and 'Oh, I don't qualify for Social
Security any more because it's means tested'," says Mr. Arnott, a
widely respected market strategist. "We're headed for a retirement
train wreck," he adds, "and it's going to get really ugly over the next
Alarmist? Perhaps. But follow the math.
returns you will get from your stock funds can only come from four
things, they note: Dividends, earnings growth, inflation and changes in
Right now the dividend yield on U.S. stocks is about
2.2%, they note. Historically, earnings have only grown by a
surprisingly low 1% a year in real, inflation-adjusted terms. Mr.
Arnott tells me the average since 1900 is only about 1.2%, and in the
last half century just 0.6%. Will we get more in the future? With the
U.S. population ageing and heavily in debt? It's hard to imagine.
Throw in a 2% inflation forecast–more on this later–and Research Affiliates forecasts a long-term return of 5.2%.
about changes in valuation? Some generations are lucky. They invest in
the stock market when it's depressed and shares are cheap in relation
to earnings. This was the case in the 1930s and the 1970s. Then they
retire and cash out when the market is booming and shares are expensive
in relation to earnings–such as in the 1960s and 1990s.
today are not so lucky. The stock market's latest rally has lifted
shares already to pretty high levels in relation to average
cyclically-adjusted earnings. This so-called "Shiller PE" (named after
Yale professor Robert Shiller, who popularized the notion) has been an
excellent indicator of market value. Right now it's at about 22–well
above its historic average of 16. The only time the market has boomed
from these levels, was in the late 1990s bubble–an atypical moment
unlikely to be repeated any time soon.
Now look at bonds. Thanks
to the recent boom, the picture for investors here looks even worse.
And there is less room for ambiguity, because bond coupons and the
repayment of principal are fixed.
Based on the yields of prices
across all investment grade bonds, Mr. West and Mr. Arnott calculate
likely long-term bond returns from here of about 2.5%.
investor with 60% of his portfolio in stocks and 40% in bonds, a
standard, if conservative, allocation, can expect a weighted average
return from here of only about 4.1%.
To put this in context, they notice that the typical big pension fund is still expecting to earn about 7% to 8% a year.
you strip out 2% inflation, that means pension fund managers are
expecting 5-6% percent a year in real, inflation-adjusted terms.
But by Mr. West and Mr. Arnott's numbers, investors can only expect about 2.1%.
Here's what this means for you.
Someone who saves $10,000 a year for 30 years and invests the money at 5.5% a year will end up with $760,000.
Someone who only manages to earn 2.5% on their investments: Just $420,000.
you're running a pension fund, this kind of shortfall leads to a
funding gap that must be made up by the plan sponsor. For a private
investor trying to build their own savings, it leads to a dismal
Is there any hope?
I asked Mr. Arnott about two possible sources of higher returns.
first: Stock buybacks. Will they help? Many companies are trying to
return more money to investors, on top of dividends, by buying back
stock. In theory, at least, this ought to boost returns, because it
reduces the number of shares, and therefore increases the value of those
that remain. But Mr. Arnott cautions against relying on it. We don't
know how big these buybacks will be, and we don't know if they're
sustainable, he says. Furthermore, the gains are usually offset by the
issue of new stock and options to management. "Most buybacks are done to
facilitate the exercise of management stock options," he says.
The second possible source of better returns: Emerging markets.
have been throwing money into emerging market funds recently like a
hail mary pass–a last, desperate bid to snatch a decent retirement from
the jaws of defeat.
But they may be substituting hope for
reason. By Mr. Arnott's math, even the most heroic calculations cannot
plausibly predict that earnings growth in emerging markets will be more
than a couple of percentage points faster than in developed countries.
And there are plenty of people who argue it won't be markedly higher,
over time, at all. Why? Where economies grow more quickly, new capital
flows in. Current investors find their returns diluted by new
enterprises and new stockholders.
Meanwhile, look at the
valuations. Stock markets in emerging economies have skyrocketed in the
past two years. Hot markets like Brazil and India have nearly
recovered their 2007 manic peaks. As a result, your dividend income is
even worse than in the U.S. The yield on the Indian stock market is
down to about 1%, according to FactSet. Brazil has dipped below 2% and
Bottom line? Neither pension funds nor private
investors seem to have fully absorbed the grim lessons of the past
decade. Returns are going to be much lower. People need to save more,
much more, for their retirement. If the market rally this year has
given them false hope, it will have turned out to be a curse more than a
I went over West and Arnott's latest report, "Hope Is Not A Strategy," and found it quite interesting. I urge you to read this report carefully, and pay particular to attention to this:
investors, keenly aware that returns will be lower than the past 30
years, have turned to alternative categories like hedge funds, private
equity, infrastructure, emerging markets, timberland, and so forth, in a
quest for equity-like returns and diversification of risk. This
eclectic group has a relatively short history, dubious data (i.e.
survivorship bias), and a heavy reliance on the most difficult metric of
all to forecast—manager alpha. Thus, Polly simply took the 75th
percentile 10-year return for the HFRI Hedge Fund of Fund Composite,
which equated to 9.4%.9 Even with the boost from survivorship bias, this
gets us no better than the top-quartile stock market return. Still, her
8% return assumption does seem within reach.
illustrates that Polly can “get there” only by assuming top quartile
results for stocks, bonds, and alternatives. Furthermore, all three must
produce these lofty results simultaneously over the same span! What
are the odds of that? Assuming these projections are representative,
this works out to 25% × 25% × 25%, or about a 1.6% chance. Yikes!
is exactly what the overwhelming majority of the U.S. retirement
market—pension funds, state budgets, IRAs, 401(k)s, etc.—is not only
hoping for but depending upon. That’s $16 trillion of assets expecting a
decade of sunshine to achieve the 7–8% targeted returns used for
planning and budgeting purposes.
report highlights the problem pension funds and individuals face when
they "hope" their rosy investment forecasts come true. They're setting
themselves up for a fall. The only way they can achieve these results is
by taking on more risk, but this can backfire if disaster strikes like
it did in 2008. Hope isn't a strategy, and even though the Fed keeps
pumping tons of liquidity into the financial system, it won't make a
difference in averting the major retirement disaster that lies ahead.