Get real on retirement returns


I wrote recently that Social Security – the bedrock of most Americans’ retirement plans – is starting to deplete its “trust fund.”

Of course, there really is no trust fund. It was never more than accounting gimmickry in my opinion.

The trust fund was invested in U.S. government bonds, which means that Uncle Sam was essentially borrowing from himself and calling it an asset.

 

 

investing

 

 

Bad Math

The larger problem is simply that Social Security is paying out more in benefits than it is taking in via tax revenues, which means the money has to be pulled from elsewhere in the budget.

In case you haven’t noticed, our government wasn’t able to balance its budget even when Social Security was running surpluses. Adding Social Security blows out the budget deficit all the worse.

The most likely “solution” is that Congress will move the goalpost by either raising the retirement age, raising taxes on benefits, or means-testing the benefits, effectively telling middle-class and wealthy Americans that they no longer qualify for the program.

 

Changing Expectations

In my opinion none of these options are that bad.  But I think they are probably going to feel that way because they are not at all what most Americans are expecting.

Let’s take this a step further and look at expectations for stock returns.

Many – perhaps most – Americans are expecting stock returns to be 8% to 10% per year or better. Their retirement plans are built around those assumptions.

But what if those returns come in below expectations?

One of my favorite models for finding a “quick and dirty” estimate for stock returns over the next decade uses the cyclically-adjusted price/earnings ratio (“CAPE”).

The CAPE compares current stock prices to an average of the past 10 years’ worth of earnings.

Using a 10-year average smooths out the booms and busts of the business cycle and makes it easier to compare valuations over time.

 

Takeaway

Using the current CAPE value, you can estimate what stock returns will look like if valuations move back to their long-term averages.

Well, stocks currently trade at a CAPE ratio of 32.5, which is more than 92% higher than the long-term average of 16.9.

Crunching the numbers, this implies that stock will actually lose 2% to 3% per year over the next decade.

In my opinion, if your retirement plan depends on gains of 8% or better, that’s a big problem.

Photo Credit: Tom Hall via Flickr Creative Commons

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Charles Sizemore
Charles Sizemore
Sizemore Capital Management LLC is a registered investment advisory firm located in Dallas, Texas. Charles Lewis Sizemore, CFA is the founder and Chief Investment Officer of the firm.