# What Is A Realistic Rate of Return For Retirement Planning

If you are in your late 40s like me, you may be already thinking about your retirement planning. Would I have enough to retire in 20 years from now? For most of us, the majority of our investments are in the form of equity in retirement accounts such as a 401(k) and IRA and/or in a taxable account. Besides our accumulated investment and savings rate over the next two decades, the rate of return from our investment plays a critical role in retirement planning. So what is a realistic rate of return to use in retirement planning? Is it 5%, 10%, or 12%?

The historical return of equity, S&P 500, since 1923 is 10.3% (not adjusted for inflation) with dividends reinvested. Is 10% return on equity over the last 90+ years a good number to use for retirement planning? If your investment time horizon is 30+ years, it may be okay to use long-term historic return. However, if your investment time horizon is 15-to-20 years, it may not be a good idea to use a 10% historic return for retirement planning.

## What Rate of Return The Experts Are Expecting?

Many financial institutions forecast 4% to 6% return on US equity over the 10 to 15 years. For instance, according to Vanguard’s 2020 Annual Economic and Outlook report, the expected normal return during the next 10-years for U.S. equity is in the range of 5.5% to 7.5%. While Morningstar Investment Management outlook is bleak, 1.7% 10-year nominal returns for U.S stocks. Yet, some predict a 7% to 8% nominal return for U.S. equity over the next 10-to-15 years.

Warren buffet said to expect 6% to 7% return in the stock market over the long-term during his conversation on Bloomberg. While Jeremy Siegel, the professor of finance at Wharton School, forecasts U.S. equity returns in the range of 5% to 6% (nominal).

In Benjamin Graham’s The Intelligent Investor, Jason Zweig wrote that “In the long run, you can reasonably expect stocks to average roughly a 6% return (or 4% after inflation).”

Most institutions forecast higher international equity return than U.S. equity return, in the range of 8% to 10% nominal over the next 10 years. While the forecast for expected returns for U.S. fixed income ranges from 1% to 2%.

## Nobody Can Predict The Future!

Nobody can predict the future! So what’s the point in reading into all these data?

Remember, besides your savings rate, you will need a rate of return as an input to estimate your portfolio value in the future. So we use the estimated rate of return for retirement planning purposes.

Based on outlooks and forecasts from various institutions and investment experts, here is the rate of returns we are using for retirement planning purposes.

- 6% nominal return from a broad based U.S. equity
- 8% nominal return from a broad based International equity
- 2% nominal return from an intermediate-term US Fixed Income

## How do you use the rate of return for your retirement planning?

Let’s look at a fictitious portfolio of two individuals; M1 and M2.

## Rate of Return and Retirement Planning for M1

Here is the summary of M1’s ending balance at retirement vs. her needs during retirement based on details blow.

**M1 – Accumulation Phase**

Current Age: 47 Years

Initial Balance: $500,000

Investment Time Horizon = 20 Years

Invest / Year (increase with inflation) = $20,000

Inflation = 2.5%

Annualized Return = 5.50% (see Table 1 Below)

**Ending Balance = $2.36 million**

**M1 – Retirement Phase**

Retirement Age: 67 Years

Number of Years to Retire: 20

Number of Years in Retirement = 30

Expense / Year = $60,000 (today’s dollars)

Inflation: 2.5%

Annualized Return = 4.40% (see Table 2 Below)

**Need = $2.29 million**

### Table 1: M1 – Rate of Return – Accumulation Phase

Investment | Allocation | Expected Return (normial) | Expected Return By Allocation (nominal) |
---|---|---|---|

US Equity | 50% | 6.0% | 3.00 |

International Equity | 25% | 8.0% | 2.00 |

Fixed Income | 25% | 2.0% | 0.50 |

Total | 100% | 5.50 |

### Table 2: M1 – Rate of Return – Retirement Phase

Investment | Allocation | Expected Return (Nominal) | Expected Return By Allocation (Nominal) |
---|---|---|---|

US Equity | 30% | 6.0% | 1.80 |

International Equity | 20% | 8.0% | 1.60 |

Fixed Income | 50% | 2.0% | 1.00 |

Total | 100% | 4.40 |

## Will M1 Have Enough to Retire?

Based on these inputs, M1’s investment portfolio value after 20 years would be approximately $2.36 million which is higher than her need of $2.29 million. **So M1 will meet her goal.**

You can use **this calculator** or any other savings calculator to estimate your required retirement nest egg.

You can use this **bankrate retirement calculator** or any other retirement calculator available through Vanguard or Fidelity to estimate your need during retirement.

## Rate of Return and Retirement Planning for M2

Here is the summary of M1’s ending balance at retirement vs. her needs during retirement based on details blow.

**M2 – Accumulation Phase**

Current Age: 40 Years

Initial Balance: $300,000

Investment Time Horizon = 27 Years

Invest / Year (increase with inflation) = $20,000

Inflation = 2.5%

Annualized Return = 5.80% (See Table 3 Below)

**Ending Balance = $3.06 million**

**M2 – Retirement Phase**

Retirement Age: 67 Years

Number of Years to Retire: 27 Years

Number of Years in Retirement = 30

Expense / Year = $75,000 (today’s dollars)

Inflation: 2.5%

Annualized Return = 4.80% (See Table 4 Below)

**Need = $3.23 million**

### Table 3: M2 – Rate of Return – Accumulation Phase

Investment | Allocation | Expected Return (Nominal) | Expected Return By Allocation (Nominal) |
---|---|---|---|

US Equity | 50% | 6.0% | 3.00 |

International Equity | 30% | 8.0% | 2.40 |

Fixed Income | 20% | 2.0% | 0.40 |

Total | 100% | 5.80 |

### Table 4: M2 – Rate of Return – Retirement Phase

Investment | Allocation | Expected Return (Nominal) | Expected Return By Allocation (Nominal) |
---|---|---|---|

US Equity | 40% | 6.0% | 2.40 |

International Equity | 20% | 8.0% | 1.60 |

Fixed Income | 40% | 2.0% | 0.80 |

Total | 100% | 4.80 |

### Will M2 Have Enough to Retire?

Based on these inputs, M2’s investment portfolio value after 27 years would be approximately $3.06 million which is below her need of $3.23 million. **So M2 may not meet her goal.**

**What can M2 do? Well, there are several things for her to consider:**

- Take a closer look at the yearly expense of $75,000 in retirement.
- Increase her savings rate during the accumulation phase.
- Take social security into account which would reduce withdrawal amount.
- Take more risk during the accumulation phase to increase return on investment.

**Let’s review each of the considerations. **

1 .What if M2 cut down yearly retirement expenses from $75,000 to $70,000?

M2 will now need $3.02 million which is below M2’s estimated account balance of $3.06 million. So she will meet her goal.

2. What if M2 increases annual contribution by 10%, from $20,000 to $22,000?

Revised estimated investment account balance would be $3.23 million which is exactly what she needs!. So M2 will meet her goal.

3. What if she counts on a social security benefit of $18,000 per year?

M2 will now need $2.46 million which is below M2’s estimated account balance of $3.06 million. So she will meet her goal.

4. What if she decides to take more risk, increase equity exposure to 90% (60% US and 30% international)?

M2’s revised estimated investment account balance would be $3.31 million which is higher than her requirement. So M2 will meet her goal.

If I were in M2’s shoes, I would concentrate on 1 (reducing retirement expense) and 2 (increasing savings rate) as both are in our control. However, I would hesitate to take more risk with my portfolio. But what about social security? More than likely, we will receive some portion of social security at retirement age even though there are numerous **reports raising concern of depleting the social security fund by 2035**. However, I would not include social security in the planning stage to stay conservative.

## Assumptions:

We have made several assumptions in the retirement planning calculations such as:

- No leftovers! Did not leave any money to heir
- Did not consider tax implication
- Fees such as expense ratio for mutual funds or retirement account management fees are not included in the analysis.
- Not accounted for any major financial expense such as major medical issue that may cost significant amount of money

So if you are expecting to be in a high income tax bracket or you have a large taxable account or you wanted to leave a large sum to your heir or expecting a large expense in the future, you may want to reevaluate your retirement planning.

## But Market Returns Are Not Constant!

For planning purposes, we have used a constant rate of return in retirement planning. It would be nice if market return stays constant year-after-year, a wishful thinking! But we know that the rate of return is not going to be constant and volatility is expected. That’s why planning for retirement is a challenge because we have to take market fluctuations into account. That’s where Monte Carlo simulation is helpful as it takes market fluctuations into account by simulating a variety of market returns. A typical Monte Carlo simulation runs thousands of scenarios to come up with a probability of success.

**Vanguard Retirement Nest Egg Calculator** is one of the simplest online calculators to determine the probability of success for your retirement portfolio. Personal Capital Retirement Planning calculator is another good choice, particularly if you want to edit your underlying assumptions such as inflation rate, social security, etc. With any Monte Carlo simulation, the output will be probability of success in percentage. For example, if the output from simulation is 80%, it means that there is a 80% chance of not running out of money and a 20% chance of running out of money over the retirement period.

Should you completely trust retirement calculators, savings calculators, and Monte Carlo simulations? I would not, as all calculators are based on a set of assumptions. These assumptions are based on past events while retirement is a future event. In addition, these calculators are not able to factor in human behavior. I would use these tools cautiously for retirement planning purposes.

## Conclusion

Nobody can predict the future; however, we can prepare for it by developing and monitoring our retirement planning. It will help us make informed decisions instead of “flying blind”. Therefore, consider planning for your retirement now by using a reasonable rate of return. Take a closer look at your expenses and estimate your yearly retirement expense. Determine your retirement “number” and consider making necessary changes to reach your “number”. Finally, consider reviewing your retirement plan at least once a year or after any major life event to make sure you are on target and make necessary adjustments as needed.

We cannot control the equity market return, tax rate, social security benefit, and direction of interest rate. Let’s concentrate on things we can control, our expenses, our savings rate, investment fees, and our ability to invest consistently.

What rate of return are you using for retirement planning? What do you think about reducing equity risk in retirement?

Thank you breaking down an otherwise speculative and cumbersome topic. The examples are helpful. Please consider adding some graphic content for visual learner like me.

Thank you for your feedback. The data is out there about rate of return but at times it is “information overload”. I am glad the examples are helping. We added graphics to the post.