Be Stingy with Your Forecasts
No one knows the future, but that shouldn't keep you from investing. Just keep your assumptions modest and presume, for example, that stocks will return about 5% a year for the next 20 years — not 11%. Ditto for your home's value. Plan on 3% growth, not the historical rate of about 6%. That way you'll force yourself to save more aggressively and have a good chance of being pleasantly surprised years from now. What do these lower assumptions mean for your planning? Look at it this way: the typical retirement portfolio fell about 30% from top to bottom in the Great Recession. All else being equal, that loss requires a 43% portfolio gain to be made whole. With average annual returns of 5%, it would take 7.3 years to get even; with average annual gains of 11%, it would take less than half that long — just 3.4 years. That means if you plan for 5% returns but get 11% returns, you'll either reach your goal twice as fast or end up with twice as much over the full period. That's sweet. By the way, there is a decent chance that historical rates of return will persist. Looking at rolling 30-year periods since the Great Depression, the S&P 500 index of large-cap stocks has never produced less than an average annual gain of 9%, and in almost every instance the average annual gain was between 10% and 12%. Yes, things are different now. We're in the throes of a slow economy with dismal returns, and that's why you need to scale back your assumptions. But at some point this too shall pass and rates of return will rise — possibly enough to live up to those long-term averages.