Retirement saving criteria creating false expectations
The criteria used to calculate retirement savings may be incorrectly calculating the level of savings required creating a false gap between reality and expectations.
Morningstar Head of Retirement Research David Blanchett said most retirement modelling looked at historical returns but did not factor in any possible lower future returns.
He stated that Morningstar modelling of the past 112 years of compound returns and 20 years of likely future returns showed the latter would be lower and would not produce the expected outcomes currently produced by standard retirement planning models.
“We looked at historical returns and possible future returns from a portfolio of cash, bonds and equities and found that average world-wide returns would be about 3.5 per cent lower than they have been to date,” Blanchett said.
He also stated that using the four per cent rule or the 25 times final year’s earnings rule to model retirement savings was inadequate and ignored risks over time.
“If returns are set to drop off for the long term then retirement incomes come under threat. The long term averages used in retirement modelling should raise red flags about the assumptions underneath them,” Blanchett said.
He stated the common assumption that retirement modelling should be based on some form of income for life plus inflation ignored the fact that retiree spending dropped off later in life and historical estimates of safe withdrawal rates no longer realistic forward-looking estimates.
“Retirement is the biggest purchase in life so it makes sense to figure out the real cost. This is a growing issue at the advice level since income modelling shapes accumulation savings.”
“I am not advocating that people stop saving or even save less but rather they save in better ways for retirement to avoid the risks of running out of money while still alive or running out of time to spend what they have saved which could have been used earlier in life.”
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