When the Wall Street Journal issues a warning we should listen. The headline read: "Retirement disaster ahead" and it cited a report by John West and Rob Arnott of Research Affiliates, an investment management firm in
They conclude that many Americans are heading toward a retirement disaster and don't even realize it. They go on to claim that even many of those running big pension funds don't know. To be blunt, and to quote Mr. Arnott, "we're headed for a retirement train wreck and it's going to get really ugly over the next 15 years."
They use some fairly compelling mathematical formulas to back this up. Consider this. The returns you get from stocks or stock funds are impacted by four things: dividends, earnings growth, inflation and changes in valuation.
The researchers point out that the dividend yield on
Now, toss in a 2% inflation forecast and Research Affiliates forecasts a long-term return of 5.2%. As for any changes in valuation, some generations are lucky. They invest in the stock market when it's depressed and shares are cheap in relation to earnings. This was the case in the 1930s and the 1970s. Then they retire and cash out when the market is booming and shares are expensive in relation to earnings-such as in the 1960s and 1990s.
But today, with boomers already entering their retirement years, they're not going to do as well. The stock market's latest rally has lifted shares already to pretty high levels in relation to what are called average cyclically-adjusted earnings.
This is the well known "Shiller Price to Earnings index" named after Yale professor Robert Shiller and has been a good indicator of market value. Right now it's at about 22 or well above its historic average of 16. And the only time the market has boomed from these levels, was in the late 1990s bubble, a situation no one expects to be repeated in the next decade.
Bonds? Even worse
As for bonds, thanks to the recent boom, the picture for investors looks even worse. And there is less wiggle room because bond coupons and the repayment of principal are fixed. Based on the yields of prices across all investment grade bonds, Mr. West and Mr. Arnott calculate that the likely long-term bond returns will be about 2.5%.
So a typical conservative investor with 60% of his portfolio in stocks and 40% in bonds can expect a weighted average return of only about 4.1%. When you strip out 2% inflation that means investors can only expect about 2.1%. What does this mean? Someone who saves $10,000 a year for 30 years and averages a 2.5% return will wind up with $420,000. That could last a few years. But probably not 20 or 30 years which is the length of time you could live in retirement.
Now, how many Americans have socked away $420,000 for retirement? Not very many, according to the Employee Benefit Research Institute, or EBRI. Earlier this year EBRI released a devastating report that said one out of every three working Americans do not have any retirement savings beyond Social Security.
The report also said that 35% of those over 65 rely almost totally on Social Security alone. But the real scare came when EBRI added that of the remaining two-thirds of working Americans who have some retirement savings was that half have saved only $2,000 or less.
With tens of millions of baby boomers entering retirement over the next 15 years, the scenario could look like something out of a "Mad Max" movie. The consequences of so many people forced to live on a couple thousand dollars a month from Social Security will turn this country into a third world nation.
Meanwhile, businesses continue to sit on more than $1 trillion in cash that could be used to create jobs but instead of using it they're keeping the cash on the sidelines because they too are worried about the future. Unemployment continues to stay at levels not seen since the Great Depression and no one in any position of authority appears to be doing anything about it.
Scared yet? Happy Halloween.
