What rate of return to use?

Anonymous101

ex-pat_scot wrote: »

Long term equities real rate of return is approx. 5%
Long term 50/50 equities/bonds rate of return is approx. 4%


http://monevator.com/uk-historical-asset-class-returns/
gives a pretty decent framework.


But what to use in planning?


Frankly I use 5% as the mean best estimate, then do scenario analysis for various real rates from 0% to 10%, to model the size of my pot under the various investment regimes.
This then gives me the range of pot values and then the choice:
- do I continue until i reach my desired pot value (/retirement income)?
- do I stop and merely accept whatever pot value / retirement income I get at that point?
- what will ACTUAL returns and pensions / tax regime do to my behaviour? (ie will i change my asset allocation, risk appetite, amounts contributed each month)


I am aware that the last few years have been rosy, and 5% real rate has been very pessimistic in practice. Much of this is due to the last 2 years and the Brexit devaluation of the £ and consequent leap in value of my global trackers. Whether this is sustainable or not, I will continue on my broad global equity strategy and 5% real return assumption, and will monitor occasionally to see where I am actually landing.

I agree with your assessment of real rates of return. I think that the 1-2% mentioned by others are extremely pessimistic compared to those discussed on other forums and articles.

I use 4% to factor in some margin of safety on the growth of my 100% equities investments

nrsql

An issue is how you factor in inflation which will depend on how you handle the pension.
As you age your expenditure inflation rate will change, and your income inflation rate won't be correlated (probably).
Basically anything you calculate will be a rough estimate and the best you can hope for is an indication of how much risk is involved.

I keep a number of measures and check them all just for peace of mind (or not).

Flim

I am extremely pessimistic. I start assuming 1% interest on all savings, and assume inflation of 4.5%......and assume all pensions grow by 80% of inflation....I then model !!!8220;up!!!8221; from that baseline...hopefully worst case scenario.

somethingcorporate

Flim wrote: »

I am extremely pessimistic. I start assuming 1% interest on all savings, and assume inflation of 4.5%......and assume all pensions grow by 80% of inflation....I then model !!!8220;up!!!8221; from that baseline...hopefully worst case scenario.

Which means you'll be getting out less than you put in (from a gross perspective). That is extremely, extremely pessimistic!

darkidoe

The figure you can reasonably predict, estimate and control is what will your expenses would be like when you retire. If you have that ballpark figure, try to match it up with various rates of return on your investments/pension figures to see what rate you need to achieve to meet your target. Sometimes it helps to work backwards.

bostonerimus

On my 60/40 portfolio I used a 5% real return, but stress tested down to 1% real return.

Rowbo

ex-pat_scot wrote: »

Long term equities real rate of return is approx. 5%
Long term 50/50 equities/bonds rate of return is approx. 4%


http://monevator.com/uk-historical-asset-class-returns/
gives a pretty decent framework.


But what to use in planning?


Frankly I use 5% as the mean best estimate, then do scenario analysis for various real rates from 0% to 10%, to model the size of my pot under the various investment regimes.
This then gives me the range of pot values and then the choice:
- do I continue until i reach my desired pot value (/retirement income)?
- do I stop and merely accept whatever pot value / retirement income I get at that point?
- what will ACTUAL returns and pensions / tax regime do to my behaviour? (ie will i change my asset allocation, risk appetite, amounts contributed each month)


I am aware that the last few years have been rosy, and 5% real rate has been very pessimistic in practice. Much of this is due to the last 2 years and the Brexit devaluation of the £ and consequent leap in value of my global trackers. Whether this is sustainable or not, I will continue on my broad global equity strategy and 5% real return assumption, and will monitor occasionally to see where I am actually landing.

The monevator article was very interesting. Thank you!

And i totally agree on the regular checking. We plan to update our spreadsheet every year at least with the most up to date figures.

Rowbo

These replies are all really helpful, thank you.

It sounds like sticking to 3 or 4% but checking our plan with lower rates is the way forward. And keeping on top of it with regular updates as we go along.

Marine_life

I have my investment returns set at 2% and inflation at 2% i.e. zero net return. I know its pessimistic but I apply the same logic as people who set their watches 10 minutes ahead (i.e. so they are never late for meetings).

I think your real rate of return will depend very much on (1) Your investment mix (2) What you do with the returns i.e. dividends reinvested. The challenge is that higher growth potential often comes with higher volatility so the most sensible approach is to first understand your tolerance for risk before asking about expected returns.

232607

lisyloo wrote: »

I am using 7% but my portfolio is aggressive and I understand it might be wrong and I'm not making any major plans on the forecast.


Given it's easy with excel spreadsheets these day you could have several %'s.

I'm also using a similar figure in the later accumulation stage, 3,1/2 years to go if I achieve it.
If it doesn't it's not the end of the world as I simply carry on.
I don't consider anything wrong with using a higher figure so long as you have a plan "B" if it doesn't make it.
Planning to use 5,1/2% in drawdown but again I have contingency plans for this.