(Money Magazine) -- I always see people saying that if you save and then earn an annual return of 7% or 8% on your investments, you should be able to accumulate enough for a decent retirement. But please tell, where, oh where, can I get a 7% or 8% return on investment these days? -- Susan, Tampa, Florida.
What? You mean you don't have your money in the "We Return 8%-a-year Guaranteed" mutual fund?" I'm kidding, of course. There is no such fund. That's not to say there aren't investments that, at first blush, may seem to offer guaranteed returns.
Putnam's Absolute Return funds shoot for an annualized return of as much as seven percentage points above inflation over roughly three years. But don't think that word "absolute" means you're absolutely, positively going to get that return.
If you check the fund's prospectus, Putnam makes clear it's really talking about a target rate of return, not a promise or guarantee. Many annuities also throw the word guaranteed around. Variable annuities often come with a "living benefit" rider that touts annual guaranteed growth rates of 5% to 7% a year.
But as I noted in a previous column, that return applies to a hypothetical account used to calculate how much annual income you can draw from the annuity. Your actual account value -- the total amount you can withdraw (minus any surrender charges) -- is determined by the rate of return the investments within the annuity actually earn, not the ballyhooed guaranteed rate.
Similarly, another breed of annuity known as a fixed- or equity-index annuity also offers various guarantees. But as my MONEY colleague Lisa Gibbs pointed out in a recent story such annuities also come with a number of very significant drawbacks.
All of which is to say that I don't know of any way to guarantee you a return of 7% a year, 8% a year or anything close (especially over the course of several decades, which is how long most of us save and invest for retirement).
Why, then, do you see a 7% or 8% return often used in examples of what size nest egg one might have at retirement time? I can't answer for others. But I can tell you that I often use a hypothetical 7% annual rate in examples when I want to give people a decent sense of how their savings might grow if they save regularly and invest in a diversified portfolio for the long term (note the emphasis on "might" and "long term.")
I see it as a rate of return that's reasonable and even achievable over the long-term, but hardly guaranteed. Someone might do better, and they could easily do worse. And I certainly don't mean it as a target or a prediction. As we've seen recently, returns jump around a lot from year to year to year.
Stocks gained about 5.5% in 2007, lost 37% in 2008, gained nearly 29% in 2009 and returned about 17% last year. Bond returns also vary year to year, although not nearly as much as stock returns. In 2007, the broad bond market gained nearly 7%, then 5% in 2008 and returned roughly 6% in both 2009 and 2010.
Even over long periods, stock and bond returns can fluctuate pretty substantially. For the 66 rolling 20-calendar-year periods from 1926 through 2010, for example, stocks returned as much as an annualized 17.9% and as little as 3.1%, according to figures from Ibbotson Associates.
The high/low for intermediate-term bonds was 10.0%/1.6%, while the max/min for a 50-50 mix of stocks and bonds was 14.8%/4.6%. Besides, even if I knew what the annualized return would be over a given period, I still couldn't predict the size of your portfolio.
That's because when you're adding money to a portfolio or taking it out over time, the pattern of returns, not just the annualized or average annual return over the period, determines how much money you'll have.
If you doubt that, try investing $100 a year using this sequence of five returns -- 28.6%, 12.6%, 9.5%, 2.5%, -13.7% -- and then do the same thing reversing the order. You'll have a different ending value ($521 vs. $735) even though the sequence itself represents an annualized 7% return).
Finally, there's no way for me to know how you, or anyone else is, actually going to invest your savings. And clearly, how you divvy up your money between stocks and bonds, the specific investments you choose and how much you pay in expenses is going to affect how much your savings will likely grow over the course of your career.
So it seems to me the real question here is how do you give yourself a decent shot at accumulating the money you'll need for a secure retirement, considering the uncertainty surrounding returns and the lack of true guarantees? Well, savvy investing is part of the answer.
But by savvy investing I don't mean looking for investments that have delivered the best returns lately or that all the pundits happen to be jabbering about at any moment -- or even that you or someone else thinks may earn a specific rate of return.
Rather, it's about putting together a diversified portfolio of stocks and bonds that's appropriate for your situation. Generally, the more years you have until retirement, the more you will tilt the mix of that portfolio toward stocks because you'll have more time to rebound from the occasional steep setbacks stocks sometimes suffer.
Someone in her 20s or 30s, for example, might have 80% to 90% of her savings in stock funds and the rest in bond funds. As you close in on retirement, you'll want to move more toward bonds to protect your savings and to prevent your nest egg's value from being decimated prior to or shortly after entering retirement.
So someone retiring at 65 might have 50% in stocks and 50% in bonds. You can get an idea of how different mixes of stocks and bonds might perform over time by going to Morningstar's Asset Allocator tool.
And you can see how changing your mix -- tilting more toward stocks or bonds or cash or large stocks or small stocks, etc. -- shifts your odds of being able to accumulate a given sum of money by retirement.
But I want to be clear that this is only an estimate based on expected returns for different assets, their volatility and how closely each asset tracks the performance of the others.
There are no guarantees when it comes to stock and bond returns. Which is why, as I noted recently, it's especially important not to neglect the other factor in building a nest egg: saving on a regular basis.
In fact, I advocate saving a bit more than you may think you need so you have a cushion. That way, you may still be able to retire with a nest egg large enough to support you even if your savings don't earn the returns you'd hoped for.
Bottom line: I wouldn't get too obsessed with earning a particular rate of return, be it 7%, 8% or any other figure. That's not something you can control. Rather, your goal as an investor is to get as much as you can of whatever returns the financial markets deliver, given the level of risk you're willing to take.
And the way to do that is to create a diversified portfolio along the lines I've suggested above. Combine that approach with a diligent savings effort, and you'll have done as much as you reasonably can do to assure a comfortable retirement.
|Overnight Avg Rate||Latest||Change||Last Week|
|30 yr fixed||3.98%||3.95%|
|15 yr fixed||3.05%||3.05%|
|30 yr refi||4.05%||4.03%|
|15 yr refi||3.12%||3.11%|
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