Ep. 19 – 21 Questions (Series) – 18. After inflation, taxes and fees, what is a reasonable estimated return on my portfolio over the long term?

Welcome to the Real Retirement Financial Planning Podcast. This series covers the 21 Questions to Ask Your Financial Advisor.   The list of questions was inspired by Jason Zweig of the Wall Street Journal, and his blog post: The 19 Questions to Ask Your Financial Adviser. Responses to Jason’s questions I read from other advisor websites lacked depth. “Yes,” or “no,” sometimes needs more context and a greater explanation into the whys. The goal of this series is to target the essence of what I think Jason is trying to protect you from, and help you make a better educated decision.  

21 Questions to Ask Your Financial Advisor

18. After inflation, taxes and fees, what is a reasonable estimated return on my portfolio over the long term?

Jason is looking for: “If I told you anything over 3% to 4% annually, I’d be either naïve or deceptive.”
  My thoughts: it’s hard to lock-in an exact forward looking return, but Jason’s return range for a moderate portfolio is close (after inflation, taxes and fees over the long-term!). Knowing this (hopefully) helps you avoid working with someone promising high returns in the hopes of winning your business. This risk is in addition to advisors who use aggressive rates of return in your planning assumptions. They could potentially mislead you with higher returns, and lead to you running out of money at the worst possible times.   Why lower returns ahead Capital market assumptions involve expected returns for each distinct asset class based on many variables. It’s terrifying to contemplate that financial planning software gives the average advisor so much leeway to either be blindly defaulted into past returns, or possess a magic wand of sorcery to jack-up return assumptions. They might say:  
“See ‘we’ just take more risk (stocks), and everything is okay…” “Historically, since 1930 stocks have earned…”
  In my view, one thing is for sure: you cannot expect rates of return we’ve generously experienced in the past will persist over the next two decades. Interest rates can only fall so far to drive capital gains in fixed income returns, in addition, to the low yield your currently earning…Bonds have a uphill climb if we look to history:

Also, credit spreads (in the U.S.) are thin right now in case you were thinking of  taking on more credit risk to get higher returns in bonds.

  Finally, at home in the U.S., we have elevated equity multiples: people are paying more and more for one dollar of earnings (P/E), cash-flow (P/CF), and book value (P/B).

If not the past, than what? We review multiple capital market forecasts to comprise our planning assumptions on a yearly basis. In the hopes our planning doesn’t drift too far from reality.  
If you have a “99% probability of success” based on this fancy software output, and no clue about the return assumptions driving your plan, there’s probably a 99% probability it’s dead wrong.

Here’s a few we use in the calculation to build-up future returns:

(1) BlackRock 

(2) GMO 

(3) J.P. Morgan 

(4) Northern Trust 

There’s others, but this isn’t a exercise in perfecting a forecast. That’s futile. It. Won’t. Ever. Be. Perfect.  

As John Maynard Keynes said, “It is better to be roughly right than precisely wrong.” 

  Ways to get played  Pitches can be outlandish. I’ve overheard passionate pleas to join the exclusive return afterlife at coffee shops, restaurants, and bars… We can get you 15%+ (or insert some crazy number here) for 20 years. I’ve lost business to be sure. Then, I walk perspective clients through how if that was true, the person they are working with would be better than…Some of the best investors of all time…

People get greedy, and look for false saviors to bring them into the return afterlife when they haven’t saved enough. Promising something that never comes, that you know will never come, is the worst way to end up in a suntan lotion needed eternity with the capital market gods. Remember!
  There two sides of the coin: Return AND Risk.  

  What can you (REALLY) get me? Breaking down returns Earning anywhere from 4% to 7% (long-term) depending on your risk tolerance and backing out inflation of 1% to 2% (long-term) gets you close to Jason’s number. A moderate risk taker could assume a 4% to 5% rate of return. Subtracting 1% for inflation gets you even tighter to Jason’s range.   Does your advisor even know how to build up the return assumptions they tout in software? Does your advisor just look at an Ibbotson chart, and explain past returns are future returns? Are you in an investment with no clue how it really works, but expecting return nirvana?