JP Morgan Asset Management’s Global Head of Retirement Solutions Anne Lester has a pretty clear warning for any institutional or individual retirement savers doing predictions with a 7% or 8% annual return assumption baked in.
“Looking at the themes that have come to define the investing markets of the last several years, and looking forward to what we know will be the case in the coming decade, achieving a 7% or 8% annual return target will be a very challenging, if not impossible, objective for portfolios to achieve,” Lester says. “Anyone still expecting to get 8% returns per year is likely to be disappointed.”
Lester, who was recognized as Morningstar’s 2015 Fund Manager of the Year, points to a by-now familiar laundry list of global factors weighing down macroeconomic growth. Whether talking about challenging tax and demographic issues in developed economies or stalling growth in emerging markets and China, there is no shortage of headwinds to account for, she explains, “such that growth will almost certainly be lower in the coming decade than the past decade.”
It’s not all bad news, though. Lester predicts some aspects of the near- and medium-term economic future will be unpleasant for most investors to face, “but it won’t be terrible.” Another way to put it, “6% will be the new 8%.”
Chief Retirement Strategist Katherine Roy agrees, noting that in the 2016 Guide to Retirement publication—the fourth update in the major research project—all return assumptions have been notched down, from “a somewhat conservative 7% for a traditional 60/40 portfolio to an even more conservative 6.5%.”
NEXT: Solutions for a tough future
“It’s an obvious implication, but this means it’s going to take more dollars invested today to reach the same target later down the road,” Roy explains. “Perhaps even more worrisome is the average annual return we are anticipating for portfolios tailored for those folks already in retirement. That’s going to be more like 5%, if not less, in the coming decades, due to the added inefficiencies of having to carry more cash and of taking less investment risk.”
Roy observes that just shaving 50 basis points off the anticipated annual return for retirement savers has major implications for how much people should be saving today. She points to one of the most commonly referenced pages from the Guide to Retirement (page 15 for those looking at the report) to make the point.
“So if we consider our retirement savings checkpoints analysis, which tells a person how much they should have saved at a given age to be on track for retirement as a multiple of current salary, the new return assumption has really shaken things up,” Roy explains. “In last years’ guide, we found that a 40-year old hoping to replace a $100,000 annual salary by the normal retirement age should have had 2.0-times the current salary saved, or $200,000. In the updated guide for 2016 relying on the 6.5% return assumption, that multiple jumps to 2.6-times current salary, for a $260,000 savings target by age 40.”
In other words, to be considered on track for full income replacement another $60,000 would be needed over what was assumed last year. “This is clearly going to be a conversation starter between advisers, plan sponsors and their participants,” Lester adds.
NEXT: Tax issues are increasingly worrisome
One concrete strategy shared by Lester and Roy to start tackling this challenging return picture is to encourage retirement plan participants to get much smarter about how they will pay the taxes they’ll ultimately owe on accumulated retirement assets.
As Roy observes, the impact of basic-seeming tax decisions, such as going with a traditional versus Roth 401(k), can have massive wealth implications later on in life. “Even today, at a time where many more employers are standing up and taking responsibility for their workers’ retirement prospects, serious misunderstanding about retirement tax deferrals remains,” Roy says. “Many people saving in 401(k) plans today are doing nothing whatsoever to plan for how they will pay the taxes on their distributions.”
In all likelihood, a given individual will see a big chunk of their defined contribution (DC) plan wealth going to the federal and state governments—likely more if they don't make a sensible plan. “For example, even at a very modest 15% tax rate, a $500,000 portfolio is really only worth $454,000 in spending power for the individual,” Roy says. “Depending on the state where one lives and other factors impacting their tax burden, the tax impact can be absolutely massive.
“Fortunately, tax risk is one of the risks the individual retirement saver can actually control,” Roy adds. “We strongly advocate that individuals work with an adviser, especially during their 50s and 60s, to properly plan how they will pay down their taxes in retirement. Often individuals face a far more difficult tax burden than they anticipated during the planning phase.”
A full copy of the 2016 Guide to Retirement is online here.