What is a reasonable real rate of return?

[Lordosis]

I use 4% real but consider 2-6%, as a possibility.
Obviously we can adjust as we go.

[Roentgen]

CM wrote:

ko wrote:

There was a recent thread over on the bogleheads forum about what real rates people use for their planning that got me thinking about whether my assumption for my planning is reasonable. What real rate do you use (or would you suggest) with the following assumptions: an 80/20 or 75/25 portfolio and investing for 25-30 years (i.e. for someone now in their early 30s).

I was surprised to see that most folks over on the other thread were saying they would use a 1% to 2.5% real rate, with a few outliers saying they use 3% to 4.5% (and maybe one person saying they’d use 5%+). There were lots of cautions to not use anything too optimistic, which seems to them to be anything more than 1.5% or 2.0%.

Does that seem right to you? What do you use? If a real rate of 2.0% to 2.5% or so really is realistic, it seems pretty challenging for most people (including a lot of medium- and high-income earners) to comfortably get to a point where they can retire with $100k or $120k per year coming from their investments (using a 4% or 3% rule for the required size of a portfolio at retirement), particularly if they want to do it before age 60 or so.

Thoughts?

Click to expand…

For US stocks: The dividend yield plus the LT real growth rate of earnings (1.25% according to Siegel, and about 1.5% according to Arnott, and about 1.55% from Shiller’s spreadsheet IIRC) minus a haircut for a fall in valuation. That is, I apply a PE10 of 15 to 20 at my horizon of interest. That change (i.e., decline) in valuation is very important over short horizons, but less so over long horizons.

For bonds: The real yield on TIPS.

Click to expand...

Sounds like you are an acolyte of William Bernstein's work.  My assumptions are basically the same.

[afan]

I use 1% real as my base plan for a 65/35 portfolio. If returns are better, great! If my lower returns come true, then I have planned for that.
The evidence shows that economists are terrible at predicting growth rates. Stuff happens.

Also terrible at predicting stock returns. Current valuations predict low LONG TERM returns, 10-20 years, with a lot of error. I don't know of anything that has been tested for presicting 50 years. Will China be the biggest economy? Will India or somewhere else have taken that spot? How far will the US fall?

Someone in the early 30s should be planning for a lifetime, figure to live to 100, maybe longer for a young doc.

[DCdoc]

I use 4% because I’m anti odd number.

[docnews]

I use 4% real because otherwise how could the 4% rule have a chance? Must actually be higher to survive the ups and downs and withdrawals still go up with inflation.

[wa2106]

docnews wrote:

I use 4% real because otherwise how could the 4% rule have a chance? Must actually be higher to survive the ups and downs and withdrawals still go up with inflation.

Click to expand...

Because 4% rule doesn't assume preservation of capital.  And it's only good for 30 years.

[nephron]

I don't see why people don't anticipate an 8% rate of return.  The s+p has a 10% rate of return over a 50 year period.   If you are mostly in stocks, I don't see why you wouldn't anticipate similar returns in the future.  I am relatively new investor (10-15 years).  I think that for the past 5-10 years, everybody has been saying to expect lower then expected returns, but in actuality, they have been higher or on average.   It seems fine to project with a 3-5% return, but if you project lower and budget accordingly, there is a downside to ending up with too much in assets when you die.   It means you were cutting spending when you did not need to, and a large inheritance is not always a good thing for kids.  The biggest risk to future returns seems to be incompetence in our government with our out of control debt/deficits.

[CM]

Roentgen wrote:

CM wrote:

ko wrote:

There was a recent thread over on the bogleheads forum about what real rates people use for their planning that got me thinking about whether my assumption for my planning is reasonable. What real rate do you use (or would you suggest) with the following assumptions: an 80/20 or 75/25 portfolio and investing for 25-30 years (i.e. for someone now in their early 30s).

I was surprised to see that most folks over on the other thread were saying they would use a 1% to 2.5% real rate, with a few outliers saying they use 3% to 4.5% (and maybe one person saying they’d use 5%+). There were lots of cautions to not use anything too optimistic, which seems to them to be anything more than 1.5% or 2.0%.

Does that seem right to you? What do you use? If a real rate of 2.0% to 2.5% or so really is realistic, it seems pretty challenging for most people (including a lot of medium- and high-income earners) to comfortably get to a point where they can retire with $100k or $120k per year coming from their investments (using a 4% or 3% rule for the required size of a portfolio at retirement), particularly if they want to do it before age 60 or so.

Thoughts?

Click to expand…

For US stocks: The dividend yield plus the LT real growth rate of earnings (1.25% according to Siegel, and about 1.5% according to Arnott, and about 1.55% from Shiller’s spreadsheet IIRC) minus a haircut for a fall in valuation. That is, I apply a PE10 of 15 to 20 at my horizon of interest. That change (i.e., decline) in valuation is very important over short horizons, but less so over long horizons.

For bonds: The real yield on TIPS.

Click to expand…

Sounds like you are an acolyte of William Bernstein’s work.  My assumptions are basically the same.

Click to expand...

I haven't read anything by Bernstein. The approach described above is just a modified dividend discount model with an adjustment for valuation.

[Panscan]

nephron wrote:

I don’t see why people don’t anticipate an 8% rate of return.  The s+p has a 10% rate of return over a 50 year period.   If you are mostly in stocks, I don’t see why you wouldn’t anticipate similar returns in the future.  I am relatively new investor (10-15 years).  I think that for the past 5-10 years, everybody has been saying to expect lower then expected returns, but in actuality, they have been higher or on average.   It seems fine to project with a 3-5% return, but if you project lower and budget accordingly, there is a downside to ending up with too much in assets when you die.   It means you were cutting spending when you did not need to, and a large inheritance is not always a good thing for kids.  The biggest risk to future returns seems to be incompetence in our government with our out of control debt/deficits.

Click to expand...

well inflation is like 2-3 % so thatd be like 6-7 % real over time and many people predict the market wont do as well in future.

[CM]

nephron wrote:

I don’t see why people don’t anticipate an 8% rate of return.

Click to expand...

Because equity returns depend on the dividend, the real rate of growth, and any change in valuation. This is just arithmetic.

The dividend is low and the valuation (based on PE10 or Tobin's Q) is high now compared to historical averages. Therefore, future returns will be lower, ceteris paribus.

If future growth is much higher than past growth, or if the valuation goes even higher than today, then future returns may match historical returns, but that is a bad bet to make.

See the graph near the top of this page for an illustration of the relationship between valuation and subsequent returns: https://earlyretirementnow.com/2016/12/21/the-ultimate-guide-to-safe-withdrawal-rates-part-3-equity-valuation/

 

[CM]

docnews wrote:

I use 4% real because otherwise how could the 4% rule have a chance? Must actually be higher to survive the ups and downs and withdrawals still go up with inflation.

Click to expand...

First, the 4% "rule" may not work. It has failed in the US in the past, and failed often in developed markets around the world.

Second, if you earned a steady 0% real return, then you'd make it 25 years on the 4% rule, which is only a "rule" for a 30-year retirement. You don't need much extra return to last 30 years, especially if you avoid a bad sequence of returns.

[docnews]

@wa2106 the 4% rule doesn't assume preservation of capital but that is what happens usually since this includes most worst case scenarios and still lasts you 30 years. Most end up with more historically after the 30 years.

[docnews]

@CM the 4% rule worked usually. Usually you end up with tons left over. The 4% rule works with many bad scenarios like drops in half because they have often followed been followed by many 10-20%+ years.

[wonka31]

6% (4% real). I believe that is on the conservative side, but would rather error on the side of caution.

[CM]

docnews wrote:

@cm the 4% rule worked usually.

Click to expand...

Yes, I know all about the 4% rule.

https://earlyretirementnow.com/2016/12/07/the-ultimate-guide-to-safe-withdrawal-rates-part-1-intro/

http://blog.iese.edu/jestrada/files/2015/08/Glidepath-2.pdf

https://drive.google.com/file/d/0B0svRQGBG_eaRjQzMFZxSjB2LUk/view

https://www.forbes.com/sites/wadepfau/2018/01/16/the-trinity-study-and-portfolio-success-rates-updated-to-2018/#6e49c6a96860