I got a call from a relative who asked my opinion regarding his retirement portfolio and what she should do. She is 40 years old and has been putting monthly contributions into several retirement plans for many years. Being that I spent a dozen years or thereabouts as a VP of an investment firm, and another 6 years as a venture capitalist, I took it upon myself to provide her with the truth behind the myth of retirement portfolios. Below is a text version of our conversation, I trust you will find it interesting as she did.
Investors have sought the advice of stock brokers, financial planners, and other professionals, to aid them in planning for their retirement. In nearly every case, these so called financial professionals, tell a story about long-term retirement planning. And that story goes something like this; in order for you to have the necessary funds you will need at retirement, you must begin putting some money into an investment account of stocks, bonds, mutual funds or a combination of those asset types every month, and you ll need to continue putting a monthly amount into the investment vehicles for as long as you can until you retire.
The story continues to make this assumption; over the years you will earn an average annual rate of return of 8% on your investments. That's a reasonable assumption. Your advisor would continue by explaining if you save $800 each month for 360 months (30 years), and you earn an average annual rate of return of 8% you will be rewarded for your discipline and financial acumen with an amount approximating $1,087,519 for your retirement years. If you spent an average of $60,000 per year at retirement, this amount would provide you 18 years of funds. Gee, $800 per month now and a little over a million at retirement . . . not bad.
You actually save approximately $288,000 but you get to spend $1,087,519 (the difference being $799,519). Everyone loves this story, but there is a dark side to the story. Let us make one quick point at this juncture: the entire scenario is dependent upon assumed earnings and assumed exponential compounding of those earnings. In essence, the value we are placing on our assumptions is more than the actual amount we are saving.
Millions of people are relying on this story to unfold just the way it was told to them. The story says that we will be rewarded for saving diligently, and combined with compounding interest of 8% per year, we will have this magical, huge sum of money for retirement. It's that simple. It's basic financial planning. The investment companies and financial planners know all too well how enticing this story is. Nearly every pension IRA, Keough, and other retirement plans through government and private interests are all based on a version of this story.
The questions you should be asking are: how reliable is this story? Does everyone get to exponentially compound all their earnings, all the time? Does it always come out as the financial advisors said it would?
Finally, you must beg the question; where does all these billions of dollars come from for everyone to cash out their compounded earnings and principle?
Most advisors would not be competent to provide you with an answer to the last question. The answer is: it comes from our share of a vibrant, growing economy. And if that is true, then the number we would be most interested in learning is certainly the real rate of growth of our economy. Interestingly, when you subtract inflation from the core economic rate of growth, on average, the per capita rate of growth is only 2% per year. You must subtract inflation to compute real growth rate of the economy.
Remember the assumed 8% average annual rate of return? Now replace the 8% with the real-world 2% average growth rate of the economy over the past few decades and what do we get? A 2% average real-world return on our investment gives us approximately $389,454, not the $1,087519 we were promised. That is a 64% decline in estimated values. We could live on the new amount for only 6.4 years spending our estimated $60,000 per year in retirement. Quite a difference.
You did what the experts told you to do. You saved and saved, and put everything ff until your retirement years. You didn't ask for more than what they told you, you only wanted the story to be true when it came your turn to cash out. The probability of 78 million baby boomers coming to retirement in the next ten years and all of them cashing out with the myth or original story intact is low, very low indeed.
What is the answer? It begins with not following the advice that was given to you years ago. And it consists of looking at alternative investments which given our economy m include gold and silver and other commodities. Keep doing what you have been doing all these years and hoping the myth is not a myth, may set you back near square one on your retirement plans.