6 ms·

Question - is it fair to use the 8% historical market average when doing these calculations (which include some of the most spectacularly productive periods in

Question - is it fair to use the 8% historical market average when doing these calculations (which include some of the most spectacularly productive periods in the American economy)? All the predictions I've seen going forward look like the average will be much lower (at least for the current generation), and a rate of 4-5% means you need a much larger nest egg to drawdown a livable amount each year in retirement. Edit: It's not clear from the essay, but I'm assuming Patrick's 8% rate is not adjusted for inflation (based on his 40k drawdown scenario - the other 3-4% would cover inflation).

tcoppi 10y ago
Depends on how conservative you want to be. For me personally I've been using an inflation-adjusted rate of 5% annually, but I consider that very conservative and hope to realize a much longer rate over my time horizon. But if I do realize only 5% annualized, I will be sure to have more than enough to not live in squalor. If realized rates over the next ~30 years are less than 5%, not only are we as a civilization going to have bigger problems than my retirement, but I don't think much anything will save you regardless of how much you are saving, unless you have a very frugal retirement.
- FabHK 10y ago
  Historical long term real rates hover around 6%, and I'd consider real rates of 5% for the next decade quite optimistic, not conservative. Also, regarding safe withdrawal rates, consider that (depending on the jurisdiction) in retirement you might have to pay taxes on the nominal rates, but then leave enough to compensate for inflation. Say: 4% nominal, pay 25% taxes, leaves you with 3%, but 2% inflation, so you can safely withdraw only 1%. Thus, conservatively, $1m might give you only 10k a year.
  - tcoppi 10y ago
    From 1871 to the end of 2015 returned 6.86% annualized in real dollars. Most 30-year periods you can pick out average either that or above, save a few odd periods. [1] I use [2] to do most of my predictions. I think you are being way conservative with assuming a 4% withdrawal rate will only give you $10k real dollars on $1m invested, but everyone has different risk tolerances and assumptions :) 1. http://www.moneychimp.com/features/market_cagr.htm http://www.moneychimp.com/features/market_cagr.htm 2. http://www.firecalc.com/ http://www.firecalc.com/
    - FabHK 10y ago
      Agreed, 1% withdrawal is (hopefully) worst case. But given the last decade, 4% strikes me as not particularly conservative. Disclaimer: I'm looking primarily at Germany and HK, where growth and equity returns, respectively, have been lacklustre over the last decade. Though, even the S&P 500 has only made 2.5% p.a. since 2000.
nostromo 10y ago
Personally, no, I don't think it is fair assumption. US GDP growth has been slowing for decades now. At some point that will be reflected in the markets and the index funds that track them. https://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&ctype=l&strail=false&bcs=d&nselm=h&met_y=ny_gdp_mktp_kd_zg&scale_y=lin&ind_y=false&rdim=region&idim=country:USA&ifdim=region&hl=en&dl=en&ind=false https://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&... (But, yes, I still invest in index funds. I just don't have the same dreamy expectations that many other people seem to have.)
- tcoppi 10y ago
  We've also had some spectacularly high inflation in the past, which tempers those GDP numbers somewhat. I otherwise agree that historical norms for equity market returns are probably overly optimistic for the future, but I wouldn't be extremely pessimistic either.
  - bobcostas55 10y ago
    That growth rate is real, not nominal.
    - tcoppi 10y ago
      So it is. It isn't very clear looking at that chart though, unfortunately. Another reason why I prefer FRED for this kind of data [1]. 1. https://fred.stlouisfed.org/series/A191RL1A225NBEA https://fred.stlouisfed.org/series/A191RL1A225NBEA
tunesmith 10y ago
I think it's ridiculously high. I have a running calculation where I figure the APY of all my 20+ years of retirement contributions, had I immediately put my contributions into an S&P-500 fund. It uses "adjusted close" prices, so it takes dividends into account. Right now it is at 7.6%. It is not inflation adjusted, so it's lower in real terms. Also, for the great majority of those 20 years, the APY was much lower. And, since most advice says to do some mix of domestic, international, and bonds, most ideal portfolios will have even lower performance. I know it's just one data point, but one reason this is lower than expected is because people tend to have more money to put into the market when times are good (and the market is high), and less money to put into the market when times are bad (and the market is low). It was true for me in terms of my contribution history, at least.
- BeetleB 10y ago
  It's not ridiculously high. He looked at a 10 year window, and you are looking at a 20 year window. 10 year windows show more volatility. And if you're concerned about "one data point", I'll give you plenty: http://blog.nawaz.org/posts/2015/Dec/pay-down-mortgage-or-invest/ http://blog.nawaz.org/posts/2015/Dec/pay-down-mortgage-or-in... For a 20 year window, it's below 6% inflation adjusted, and close to 8% without taking into account inflation (closer to your 7.6% figure)
tedmiston 10y ago
If memory serves me correctly, the average number you'd see used everywhere pre-2008 was more like 10%. The problem with looking at extremely long periods of time (i.e., 50 years) is you see these massive events like depressions and the housing crisis. How many of those will happen in the next few decades... who knows? Maybe we'd be better off to look at median percentages than averages.
deleted 10y ago
[deleted]
misnamed 10y ago
No, it is not fair. If you look at the global stock market (which is 'the market' as such) the returns have not been that high. 8% is based on a nation that has indeed done exceptionally well. If you look at current P/E ratios and dividend yields it is almost impossible we would see that as a consistent average going forward. Also look at bond yields: very very low - so a balanced portfolio will do less well, too.
ryandrake 10y ago
It's got to be too high. As someone who has survived two steep market corrections and have been in and out of the market as life through me difficult pitches, I'd estimate my "returns" have barely averaged around inflation--I basically have what I put in. It's potentially a mistake to just assume you'll average 8% going forward forever.
- dsacco 10y ago
  What country are you in? As of 2015 the S&P 500's average annualized return was ~8% for the past 20 years. In terms of individual years, the benchmark nearly always beats inflation handily. If you're an American and you were passively investing in index funds, I don't understand how you could only have what you started with, or anything near that amount.
  - ryandrake 10y ago
    Like I said, unlucky in that I had to stop investing and take money out during downturns (which typically happen at the bottom of the market). Not timing the market or "actively investing", you know--dealing with real life. The whole "you'll average 8%" (or 5% or whatever number gets quoted) is an idealized figure assuming you always buy and hold periodically and regularly and never need to stop or withdraw to deal with life's many curveballs.
    - dsacco 10y ago
      Ah, I understand now. I didn't understand your original comment when you were trying to point that out.
  - FabHK 10y ago
    Since the 2000 peak, the S&P 500 has returned ~3% pa. Throw in the fact that many funds back then were charging some 2% pa, and transaction costs with some in and out, and you can easily have not much more than what you started with (particularly in real terms).
BeetleB 10y ago
I did this analysis a while ago: http://blog.nawaz.org/posts/2015/Dec/pay-down-mortgage-or-invest/ http://blog.nawaz.org/posts/2015/Dec/pay-down-mortgage-or-in... The first question is: What window are you looking at? For 30 years, it's about 6.8% for the last 30 years (inflation adjusted - close to 10% if you ignore inflation). I've plotted it for each 30 year period going way back. 6.8% is not high. It's been well over 10% a number of times. I think 7% is a good average. His figure was from a 10 year window. Unless you plan to retire in that timeframe, I would suggest just looking at a larger window. Less volatility. Oh, and based on my plots, his 8% looks like it is inflation adjusted.
torkins 10y ago
It's ridiculously high. For a better evaluation, see probably one of my favorite visualizations of all time: http://www.nytimes.com/interactive/2011/01/02/business/20110102-metrics-graphic.html?_r=0 http://www.nytimes.com/interactive/2011/01/02/business/20110...
- jjguy 10y ago
  THIS This single diagram explains the market dynamic year over year in a way I've never seen anywhere else. The 1/3/5/10 yr returns figures you see don't even come close to understanding the nuances of one year over another. I remember when this diagram was published in 2011 and _still_ refer to it routinely. This is why you do dollar cost averaging and steadily invest every year, to spread out your investments over multiple years.
  - torkins 10y ago
    I'm glad you like it but I don't follow how you infer dollar cost averaging from this. There's no statistical advantage to dollar cost averaging over lump sum investing (actually the opposite due to the median return beating inflation). I'd argue the main benefit is a realistic expectation and understanding of the range of returns to help you plan better.
    - bzbarsky 10y ago
      Dollar cost averaging doesn't have a better expected value than lump sum investing, but it should have a lower variance, no? Also, there's dollar cost averaging like "I have a lump sum now, but I will invest it slowly over the next 2 years" and there is dollar cost averaging like "I will invest money as it comes in slowly over the next 2 years instead of saving it up and investing it as a lump sum then". The former is the technical definition, but the latter is what most people mean when they use the term informally...
- cairo140 10y ago
  I feel this graphic, while informative and delightful, is insidious in its choice of scale and its lack of comparisons. On scale, it makes it seem like +3% to +7% real returns is "neutral". This makes it seem like the stock market is sometimes good sometimes bad but overall it may as well be just okay. On comparisons, it does a huge disservice by not adding a tab showing bond yields and a tab showing cash/treasury yields (which would be dark red across the board except light red around 1930). I feel these slights make the graphic present stock investing in an unfairly unfavorable light and makes the suboptimal strategy of keeping your money out of the market seem much more favorable than it is.

tcoppi 10y ago

Depends on how conservative you want to be. For me personally I've been using an inflation-adjusted rate of 5% annually, but I consider that very conservative and hope to realize a much longer rate over my time horizon. But if I do realize only 5% annualized, I will be sure to have more than enough to not live in squalor. If realized rates over the next ~30 years are less than 5%, not only are we as a civilization going to have bigger problems than my retirement, but I don't think much anything will save you regardless of how much you are saving, unless you have a very frugal retirement.

FabHK 10y ago
Historical long term real rates hover around 6%, and I'd consider real rates of 5% for the next decade quite optimistic, not conservative. Also, regarding safe withdrawal rates, consider that (depending on the jurisdiction) in retirement you might have to pay taxes on the nominal rates, but then leave enough to compensate for inflation. Say: 4% nominal, pay 25% taxes, leaves you with 3%, but 2% inflation, so you can safely withdraw only 1%. Thus, conservatively, $1m might give you only 10k a year.
- tcoppi 10y ago
  From 1871 to the end of 2015 returned 6.86% annualized in real dollars. Most 30-year periods you can pick out average either that or above, save a few odd periods. [1] I use [2] to do most of my predictions. I think you are being way conservative with assuming a 4% withdrawal rate will only give you $10k real dollars on $1m invested, but everyone has different risk tolerances and assumptions :) 1. http://www.moneychimp.com/features/market_cagr.htm http://www.moneychimp.com/features/market_cagr.htm 2. http://www.firecalc.com/ http://www.firecalc.com/
  - FabHK 10y ago
    Agreed, 1% withdrawal is (hopefully) worst case. But given the last decade, 4% strikes me as not particularly conservative. Disclaimer: I'm looking primarily at Germany and HK, where growth and equity returns, respectively, have been lacklustre over the last decade. Though, even the S&P 500 has only made 2.5% p.a. since 2000.

nostromo 10y ago

Personally, no, I don't think it is fair assumption. US GDP growth has been slowing for decades now. At some point that will be reflected in the markets and the index funds that track them. https://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&ctype=l&strail=false&bcs=d&nselm=h&met_y=ny_gdp_mktp_kd_zg&scale_y=lin&ind_y=false&rdim=region&idim=country:USA&ifdim=region&hl=en&dl=en&ind=false https://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&... (But, yes, I still invest in index funds. I just don't have the same dreamy expectations that many other people seem to have.)

tcoppi 10y ago
We've also had some spectacularly high inflation in the past, which tempers those GDP numbers somewhat. I otherwise agree that historical norms for equity market returns are probably overly optimistic for the future, but I wouldn't be extremely pessimistic either.
- bobcostas55 10y ago
  That growth rate is real, not nominal.
  - tcoppi 10y ago
    So it is. It isn't very clear looking at that chart though, unfortunately. Another reason why I prefer FRED for this kind of data [1]. 1. https://fred.stlouisfed.org/series/A191RL1A225NBEA https://fred.stlouisfed.org/series/A191RL1A225NBEA

tunesmith 10y ago

I think it's ridiculously high. I have a running calculation where I figure the APY of all my 20+ years of retirement contributions, had I immediately put my contributions into an S&P-500 fund. It uses "adjusted close" prices, so it takes dividends into account. Right now it is at 7.6%. It is not inflation adjusted, so it's lower in real terms. Also, for the great majority of those 20 years, the APY was much lower. And, since most advice says to do some mix of domestic, international, and bonds, most ideal portfolios will have even lower performance. I know it's just one data point, but one reason this is lower than expected is because people tend to have more money to put into the market when times are good (and the market is high), and less money to put into the market when times are bad (and the market is low). It was true for me in terms of my contribution history, at least.

BeetleB 10y ago
It's not ridiculously high. He looked at a 10 year window, and you are looking at a 20 year window. 10 year windows show more volatility. And if you're concerned about "one data point", I'll give you plenty: http://blog.nawaz.org/posts/2015/Dec/pay-down-mortgage-or-invest/ http://blog.nawaz.org/posts/2015/Dec/pay-down-mortgage-or-in... For a 20 year window, it's below 6% inflation adjusted, and close to 8% without taking into account inflation (closer to your 7.6% figure)

tedmiston 10y ago

If memory serves me correctly, the average number you'd see used everywhere pre-2008 was more like 10%. The problem with looking at extremely long periods of time (i.e., 50 years) is you see these massive events like depressions and the housing crisis. How many of those will happen in the next few decades... who knows? Maybe we'd be better off to look at median percentages than averages.

deleted 10y ago

[deleted]

misnamed 10y ago

No, it is not fair. If you look at the global stock market (which is 'the market' as such) the returns have not been that high. 8% is based on a nation that has indeed done exceptionally well. If you look at current P/E ratios and dividend yields it is almost impossible we would see that as a consistent average going forward. Also look at bond yields: very very low - so a balanced portfolio will do less well, too.

ryandrake 10y ago

It's got to be too high. As someone who has survived two steep market corrections and have been in and out of the market as life through me difficult pitches, I'd estimate my "returns" have barely averaged around inflation--I basically have what I put in. It's potentially a mistake to just assume you'll average 8% going forward forever.

dsacco 10y ago
What country are you in? As of 2015 the S&P 500's average annualized return was ~8% for the past 20 years. In terms of individual years, the benchmark nearly always beats inflation handily. If you're an American and you were passively investing in index funds, I don't understand how you could only have what you started with, or anything near that amount.
- ryandrake 10y ago
  Like I said, unlucky in that I had to stop investing and take money out during downturns (which typically happen at the bottom of the market). Not timing the market or "actively investing", you know--dealing with real life. The whole "you'll average 8%" (or 5% or whatever number gets quoted) is an idealized figure assuming you always buy and hold periodically and regularly and never need to stop or withdraw to deal with life's many curveballs.
  - dsacco 10y ago
    Ah, I understand now. I didn't understand your original comment when you were trying to point that out.
- FabHK 10y ago
  Since the 2000 peak, the S&P 500 has returned ~3% pa. Throw in the fact that many funds back then were charging some 2% pa, and transaction costs with some in and out, and you can easily have not much more than what you started with (particularly in real terms).

BeetleB 10y ago

I did this analysis a while ago: http://blog.nawaz.org/posts/2015/Dec/pay-down-mortgage-or-invest/ http://blog.nawaz.org/posts/2015/Dec/pay-down-mortgage-or-in... The first question is: What window are you looking at? For 30 years, it's about 6.8% for the last 30 years (inflation adjusted - close to 10% if you ignore inflation). I've plotted it for each 30 year period going way back. 6.8% is not high. It's been well over 10% a number of times. I think 7% is a good average. His figure was from a 10 year window. Unless you plan to retire in that timeframe, I would suggest just looking at a larger window. Less volatility. Oh, and based on my plots, his 8% looks like it is inflation adjusted.

torkins 10y ago

It's ridiculously high. For a better evaluation, see probably one of my favorite visualizations of all time: http://www.nytimes.com/interactive/2011/01/02/business/20110102-metrics-graphic.html?_r=0 http://www.nytimes.com/interactive/2011/01/02/business/20110...

jjguy 10y ago
THIS This single diagram explains the market dynamic year over year in a way I've never seen anywhere else. The 1/3/5/10 yr returns figures you see don't even come close to understanding the nuances of one year over another. I remember when this diagram was published in 2011 and _still_ refer to it routinely. This is why you do dollar cost averaging and steadily invest every year, to spread out your investments over multiple years.
- torkins 10y ago
  I'm glad you like it but I don't follow how you infer dollar cost averaging from this. There's no statistical advantage to dollar cost averaging over lump sum investing (actually the opposite due to the median return beating inflation). I'd argue the main benefit is a realistic expectation and understanding of the range of returns to help you plan better.
  - bzbarsky 10y ago
    Dollar cost averaging doesn't have a better expected value than lump sum investing, but it should have a lower variance, no? Also, there's dollar cost averaging like "I have a lump sum now, but I will invest it slowly over the next 2 years" and there is dollar cost averaging like "I will invest money as it comes in slowly over the next 2 years instead of saving it up and investing it as a lump sum then". The former is the technical definition, but the latter is what most people mean when they use the term informally...
cairo140 10y ago
I feel this graphic, while informative and delightful, is insidious in its choice of scale and its lack of comparisons. On scale, it makes it seem like +3% to +7% real returns is "neutral". This makes it seem like the stock market is sometimes good sometimes bad but overall it may as well be just okay. On comparisons, it does a huge disservice by not adding a tab showing bond yields and a tab showing cash/treasury yields (which would be dark red across the board except light red around 1930). I feel these slights make the graphic present stock investing in an unfairly unfavorable light and makes the suboptimal strategy of keeping your money out of the market seem much more favorable than it is.