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Many investors are obsessed with spectacular stock-market success stories like Nvidia NVDA, -1.91% NVDA, -1.91%, which has beaten inflation over the past year by close to 200 percentage points. But you’re kidding yourself if you expect your retirement portfolio to beat inflation by even one-tenth that amount.
Yet that’s just what many investors foresee. A 2023 Natixis Survey found that U.S. investors on average believe their portfolio will outdo inflation by 15.6% annualized over the long term. In truth, the U.S. stock market, since 1793, has beaten inflation by 6.1% on an annualized basis, according to a database maintained by Edward McQuarrie of Santa Clara University. Nowadays, even that average is likely too optimistic.
Persuading investors to be more realistic won’t be easy. It doesn’t help that financial advisers — who are supposed to help investors be realistic about retirement planning — are themselves overly optimistic. Natixis reports that the average adviser expects global stocks to outperform inflation by 9% annualized.
The reason the historical 6.1% average is too optimistic for the next decade or two is that stocks are extremely overvalued. Consider the eight valuation indicators that I have found to have the best track records when predicting the S&P 500’s SPX subsequent 10-year total real return. For each, I constructed an econometric model based on its historical correlation to the market’s subsequent return, and then used that model to project the S&P 500’s return over the next decade. The average of all eight is for an inflation-adjusted total return of negative-1.9% annualized between now and 2034.
Bonds are also projected to be a below-average performer in coming years, though they should do better than stocks. One way to project their future return is from TIPS — U.S. Treasury Inflation-Protected Securities. The 10-year TIPS recently had a real yield of 2.0%, which means that if held to maturity it is guaranteed to produce a return that is 2.0% annualized above inflation.
This discussion puts in context the just-released 2024 edition of Vanguard Group’s yearbook, “How America Saves,” which summarizes the behaviors and experiences of the almost 5 million defined-contribution-plan participants with accounts at the investment-management giant. If the stock and bond markets perform as poorly as those eight valuation models suggest, the U.S. will have an even bigger retirement crisis in the coming years.
To illustrate, take the median retirement saver with a 401(k) account, as represented by the Vanguard data. He is 43 years old and has 24 more years before hitting full retirement age. This saver’s 401(k) is worth $35,286, his annual salary is $82,000, and he is allocating 11% of the salary to his 401(k) (between his own deductions and his employer match). He furthermore allocates 74% of his retirement account to equities.
These numbers enabled me to calculate how big a retirement portfolio this hypothetical median account holder would have in 24 years. I used the stock- and bond-return assumptions discussed above, and made a number of additional assumptions, such as that his salary grew at the historical inflation-adjusted rate of the past two decades, and that the non-equity portion of his 401(k) is invested in TIPS.
Given these assumptions, the median Vanguard investor’s 401(k) will be worth $231,000 in today’s dollars at his full retirement age. One way of putting this amount in context is to see how much of an annuity could be purchased with it. While the answer depends on where interest rates will be in 23 years, as of today, this $231,000 could purchase an annuity that would pay $1,557 per month for the rest of this investor’s life (according to the annuity calculator at ImmediateAnnuities.com). That’s a very modest retirement income, to say the least.
What if we assume that the equity and bond markets over the next two decades do as well as the historical average? The median 401(k) Vanguard investor will be better off in that event, though still not with a particularly cushy retirement. My calculations are that, in this event, that 401(k) at full retirement age will be worth $523,000 in today’s dollars, which could be used to purchase an annuity (at today’s rates) of $3,525 per month for life. That’s $42,300 on an annual basis, which is half of the median investor’s current salary.
Investors may be betting that superior market timing can pay off. But staking your retirement on timing the market is even less of a good bet, since on average, investors lag the markets. As you can see from the chart above, the average 401(k) investor at Vanguard has underperformed the stock market in four of the past five years, and has lagged a balanced stock/bond portfolio that follows the equity allocation of the average 401(k) investor at Vanguard.
Given the investing picture today, investors can only hope that the stock and bond markets in coming years will do better than they have historically. But hope is not a strategy. Equities’ current overvaluation and bonds’ below-average real rates make it clear that you should prepare for below-average returns — and be pleasantly surprised if the markets do far better.