How Investors' Life Stages Affect Their Retirement Savings Viewpoints
In the third quarter of 2016, the Wells Fargo/Gallup Investor and Retirement Optimism Index jumped to its highest level since mid-2007. This is great news, especially considering how often we hear about there being a retirement crisis brewing. People don’t save enough and we’re living longer. Many are choosing to plan for retirement by not taking your traditional retirement.
However, investors’ perceptions depend critically on how their portfolios are allocated. This brings to mind Miles’ Law, coined by Truman administration official Rufus Miles, who said, “Where you stand depends on where you sit.” It’s hard to be objective about anything, especially when you are personally affected by the outcome.
Where do investors stand? How life stages affect viewpoints
For investors, what is the bigger threat: market volatility or low interest rates? For investors in retirement, 47% fear continued low rates while 42% fear market volatility, according the Wells Fargo/Gallup survey. The slight edge for low rates is probably stems from the fact retirees tend to be more heavily allocated in fixed income. As for non-retirees, only 38% fear low interest rates, while 52% fear market volatility. This could stem from the fact that many investors who are still saving for retirement tend to be more heavily allocated in stocks.
Non-retirees tend to have a lot more debt than investors who are in retirement. That’s probably why 71% of non-retirees said low interest rates—which can lower borrowing costs—are good for their finances, while only 41% of retirees prefer low rates. This difference in viewpoints underscores why it’s so important for investors to look at all of their finances holistically, and not just segregate their investments from their other finances. Some risks can be inadvertently overlooked if you aren’t looking at the whole picture.
By all accounts: The value of viewing financials holistically
Similarly, some risks may be exaggerated if investors are looking at their various investment and personal finance accounts in isolation. I see this often when it comes to cash. The average non-retiree investor in the Wells Fargo/Gallup survey had 29% of their portfolio in cash, CDs, or money markets. The average retiree had 35%. That’s a lot of low-to-no interest or growth. Many investors view holding cash as a way to manage risk. It can be, but those investors also have to be willing to put cash to work, when the time is right. That type of market timing can be dangerous. Sitting in a cash position that is zero-yielding can actually mean negative-yielding, when adjusted for inflation.
The chart below shows the trade-off between the average annual return and the standard deviation (or ups-and-downs an investor would endure) based on various hypothetical portfolios. The outcomes suggest there is no one right answer, as an appropriate allocation depends on a person’s goals, resources, and tolerance for risk.
Historically, when real returns on cash have been mildly negative (between 0% and -3%), the risk-return picture for the next 12 months changes a bit in favor of stocks and cash. This is because bond yields are also typically lower, and more volatile, than they are during time periods when real return on cash is positive.
Reasonable expectations: Ways to think about returns
So, holding more cash can make sense, but only for a while. If we are entering a period in which inflation is rising, it can make sense to start easing out of cash and into stocks and bonds. What should reasonable expectations be for returns? According to the Wells Fargo/Gallup survey, investors expect an average investment return of 7% on their portfolios. For a 60% stock and 40% bond portfolio, assuming we have 2% inflation, the average historical return would be 8.4%, based on the S&P 500 Index and the Treasury 10-year Return Index. But starting from such a low return on cash (-1.2%), something closer to 5.6% seems more reasonable. These projections are based on annualized long-term nominal returns, which can be thought of as spanning the next five to seven years.
With such low rates of return, investors can help improve their savings situations by increasing the amount they save, by saving for a longer period by working longer, by investing more aggressively, or by adjusting their lifestyles in retirement. None of these options are easy things to do. Perhaps a mix of the four will be the easiest to stomach. A key consideration for investors who are considering ways to catch up on their retirement savings is that being more aggressive can only do so much—especially if it means taking on more risk than an investor is comfortable with. Aggressive investing can have nasty side-effects, like losses. Working with a trusted financial advisor can help investors set realistic expectations, craft a feasible plan, and keep themselves accountable in executing that plan.
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The views expressed are as of 12-6-16 and are those of Dr. Brian Jacobsen, CFA, CFP®, and Wells Fargo Funds Management, LLC. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the authors and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.
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