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A 5% Return: What Are the Odds?

A key element in retirement planning is the rate of return assumption – and a new report takes a look at not only what return assumptions are common, but the odds of achieving it.

Research Affiliates looked at the default returns embedded in 11 retirement calculators, robo-advisors and “institutional investor surveys built on hundreds of underlying participants,” and found that the average and median annualized long-term expected returns were 6.2% and 6.0%, respectively. They turned those nominal forecasts into real, or after-inflation, returns by subtracting a market forecast of inflation, and used the yield difference between 10-year U.S. Treasuries and 10-year U.S. TIPS, better known as breakeven inflation (BEI) (as of Sept. 30 the 10-year BEI was 1.6%). All that by way of concluding that, on average, we all expect a 5% return.

So, what are the odds that we will achieve that return we all (apparently) expect?

They first took a typical balanced portfolio of 60% stocks/40% bonds (as embodied in the $29.6 billion Vanguard Balanced Index Fund (VBINX)). For the decade ended Sept. 30, that fund had an average annual performance of 6.6% before inflation. Over the next decade, according to the report, “the ubiquitous 60/40 U.S. portfolio has a 0% probability of achieving a 5% or greater annualized real return.”

How about what the authors termed a “typical” public pension plan with 24% in non-U.S. assets and a small dash, 6%, of diversifying strategies? That would have only a 7% chance of achieving a 5% real return over the next 10 years.

What about a target-date fund? Well, a TDF+10 (one that corresponds to an investor’s retirement horizon being 10 years from the current date) today achieves a real return of 5% in only 6% of their range of returns. What about funds with longer target-date horizons? Not much better: The TDF+20 and TDF+30 have 9% and 13% probabilities, respectively, of making a 5% annualized real return based on their glide paths over the next 10 years, according to the report.

So, what are YOUR odds? You can check out your own possibilities with the 5% Challenge at www.researchaffiliates.com/5percent.

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