Jeff Voudrie’s Weekly Stock Market Commentary – October 30th, 2015

Jeff Voudrie’s Weekly Stock Market Commentary – October 30th, 2015

Jeff Voudrie’s Weekly Stock Market Commentary – October 30th, 2015

Jeff’s Weekly Stock Market Commentary: Traditional Financial Planning

I believe that the average stock market returns over the next 5-10 years may be considerably less than the 8% a year that the financial planners say you should expect. This is just one topic that I cover in the quarterly review.

Why Traditional Financial Planning Has Failed So Many Retirees (this is an updated version of an article that I published several years ago….)

People who have retired in the last 5-10 years are facing daunting challenges. Adding to their frustration is that the financial plan (upon which they based their decision to retire) indicated that they should be able to live comfortably for the rest of their lives.

I believe that those financial plans may fail because they were based on erroneous assumptions.  Unless retirees recognize this and make the proper adjustments, they risk running out of money well before their life expectancy and become dependent on their children and/or the government to meet their basic needs.

Traditional financial planning is based on the assumption that the future will bear some resemblance to the past. The rates of return used in most financial plans, the last 5 years or so, are based on the historical returns associated with each class and category of investments.

For example, the return and expected volatility (risk) of large cap value investments is based on what has occurred the past 30 years. Supposedly, that is a large enough sample to cover the majority of likely outcomes. So the overall return of your expected portfolio is based on historic performance.household-862587_1920

This approach worked well for many years—until it didn’t. I believe the traditional assumptions no longer hold true and that financial plans need to include situations and market conditions that previously had a very low probability of occurring.

Why should they be used? Because these ‘tail events’ are what pose the greatest risk to the overall success of the financial plan. It’s these ‘tail events’ that are going to result in those that retired in the last decade running out of money years, even decades earlier than what they thought. It especially impacts those at or near retirement right now.

For example, traditional financial plans are still estimating an average annual return for equities of 8% or greater and average annual returns for bonds at over 4%. Even if they assume variable rates of return the results are going to be skewed because of the underlying assumption that long-term results will equal historic results.

Recently I ran a retirement income stress test (an innovative process I’ve developed) on the retirement income plan of someone with a $1.3 million portfolio. The traditional planning software gave his plan a 99% probability of success! Of course, it assumed an average annual rate of return that far exceeds anything he has earned the last 5 years. That means that he will need to earn far in excess of 10% a year to make up for the last five years and get back on track.

Using what I (and most retirees) consider more realistic rates of return, the probability of success dropped from 99% to only 8%. There was a 91% DECLINE in the probability of success just by assuming an annual return in of 5% instead of 10%.

Fortunately, this person found out this sobering news while he still has time to do something about it. By adjusting the way he is invested and how it is managed, we have been able to significantly increase his probability of success even if returns remain as they have been the last 5 years. He doesn’t have to make drastic changes to his lifestyle.

What makes the impact of traditional financial planning potentially even more harmful is that their current estimates are based on what has occurred the last 20-30 years.  That sounds like a long time and that it should take into account both bull and bear markets, thus giving a more realistic ‘average’. And many people believe that the crashes that occurred in 2000 and 2008 were ‘bear’ markets. Using that viewpoint, financial planners believe that their assumptions incorporate both ‘bull’ and ‘bear’ markets.

But “what if”?

glasses-598209_1920What if 2000 and 2008 weren’t bear markets? What if, instead, those periods were only corrections within the longest ‘bull’ market in the history of the U.S. markets? From that viewpoint, the financial planning assumptions do not incorporate any ‘bear’ market instances and instead are based ONLY on a raging bull market scenario!

Can you see how that could lead to some forecasting problems?

Back in 1929, it took something like 26 YEARS for the market to recover what was lost. That’s considerably longer than the 3-5 years that it took to recover from the corrections in 2000 and 2008.

Now we are in a position where the current economic conditions are the exact opposite of what led to the Greatest Bull Market. Interest rates at the start of it were in double digits, now they are at the zero bound. Back then, we had double digit inflation; now inflation is only running 1 or 2%. When interest rates go down it creates a tailwind for stocks. Rising rates are a headwind.

I could go on and on about the differences between 1980 and now, but the bottom line is that the world economy is facing slowing global growth and many countries (including the US) will likely enter recession in 2016.

It is possible that we may be entering an era of growth that is considerably less than what the financial planning industry has been forecasting. If that occurs, it has the potential to be devastating for the retirees that have followed the financial planning industry’s advice.

For Common Sense Advisors, I’m Jeff Voudrie.

 

The recent Fed decision to not raise interest rates has resulted in Jeff changing his clients exposure to stocks and bonds. If you would like to have a 30 minute consultation about your allocation and get his feedback.

You can go here and schedule your free 30 minute consultation now. 

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