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Ted Leber

Bernstein Provides Some Retirement Planning Advice

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For all who desire their continuing education, this is worth your time.

Cheers, Ted






"Retirement planning is one of Mr. Bernstein's pet peeves. He thinks most of us save too little and are still expecting far too much in market returns.


He answered our queries (the standard seven plus a bonus eighth) via e-mail.


1. What's the biggest misperception people have about retirement investing?


I'd point out three. First, people think they're going to get a 7% real stock return over time. That was a one-time gift [during a bull market], and not many people got it. Second, the overwhelming majority of investors still believe in the Returns Fairy -- that their money managers can beat the market for them. Third, they also believe in the Market Timing Fairy -- that newsletter writers and investment strategists know where the markets are headed.


2. In planning for our retirement, what's a sensible return to expect from equities?


People tend to confuse economic growth with [stock] price growth. True, the nation's GDP [gross domestic product] grows at an average rate of just over 3.5% a year. But thanks to the investment bankers, we lose about 2% of that to net new-share issuance, so the real per-share increase in dividends and earnings is in the vicinity of just 1.5% a year. Three years ago, no one believed that, but recently it's gotten easier to understand. Add to that a 1.5% dividend, and hey presto, you can expect about a 3% real return from stocks.


Naturally, I'd prefer real portfolio returns, inclusive of expenses, of about 5% a year. I'd also like there to be a Santa Claus.


3. No matter what our age or net worth, we all have to figure out how much we'll need in retirement and how much we'll have to save to get there. How do we answer both questions?


It's not easy. The simplest way to calculate the size of your required nest egg is to divide how much you'll need from it each year by the expected real rate of return. If you'll need $50,000 a year [after taxes] to live on and $20,000 will come from Social Security, that leaves $30,000 you'll need annually from your portfolio. A nice, conservative return assumption is about 3% a year of real return [after inflation], so you'll need a cool $1 million, $30,000 divided by 0.03, to accomplish it.


Figuring out how much you'll need to save each month to get there is much harder. You'll need a retirement calculator or skill with spreadsheets. It's a good idea to do all your calculations in after-inflation terms -- again, a 3% assumption is a good, conservative figure. It's also a very grim calculation, so the earlier you start saving, the better. If you're 25 years old, intend to retire at 65 and expect a 3% real return, you'll find that you need to save about $1,100 a month to be reasonably certain of a secure retirement.


If you start at age 45, you'll have to save about $3,000 a month. Of course, this calculation is very sensitive to whatever return you assume. If you assume a 5% real return and expect to retire at 65, the amount you need to save each month if you start at 25 goes down to about $400. If you start at 45 it goes down to about $1,500 a month.



4. Q&A: Bernstein on Retirement (Part 2)

blbarnitz| 05-30-03 | 04:14 AM



4. Can you rough out the process of building and maintaining a sensible retirement portfolio?


That's relatively simple. Step one: Figure out your risk tolerance. If the past three years have been good for anything, it's to get a good fix on how much risk you can handle. That tells you what your overall stock/bond allocation should be. For most folks, it won't be too far from 60% stocks and 40% bonds.


Step two: Allocate your stock holdings between large-cap stocks, small-cap stocks, REITs [real estate investment trusts] and foreign stocks. A 24%, 12%, 12%, 12% portfolio weighting, respectively, is a good place to start.


As for fixed-income, invest most of your bond allocation in a short-term, high-quality corporate bond fund. If you're adventuresome, you might invest some money in a junk or high-yield bond fund when the credit spreads are attractive and have a small position in a foreign bond fund as well.


5. Some have postulated that the wave of retiring Baby Boomers will add selling pressure to stocks for years, just as they added buying momentum before their retirement. Do you buy that idea?


Not only do I buy it, I consider it an accounting identity [fact]. Someone has to be taking the stocks and bonds off the boomers' hands when they want to retire. That's one of the reasons why I quote such low portfolio returns. At the end of the day, stocks, bonds, and Krugerrands are just a medium of exchange between the folks who sell goods and services and the folks who buy them. In a world with more and more retirees and fewer and fewer workers, the amount of goods and services you're going to be getting for your securities will get progressively smaller.


6. If waves of retirees will severely sap Social Security in coming years, should investors under 30 factor Social Security benefits into their planning?


It'll always be there, but probably at a reduced level. If I were 30, I'd figure on receiving three quarters of the current benefit [estimated in annual statements mailed to investors about 90 days before their birthday].


7. The average 401(k) balance was just $45,634 at the end of last year, according to a study by the Vanguard Group. Given many investors' whittled assets, the state of Social Security and the costs of health care, is it safe to say that the retirement system is in crisis?


"Crisis" is too strong a word. It's not a crisis when people have to work a few years longer, particularly when their expectations were unrealistic to begin with. When people can't get health care, food, or shelter, that's a crisis. Having to work until 67 or 73 doesn't meet my criteria for a crisis.


It all gets back to the demographic problem. When [German Chancellor Otto von] Bismark established the [world's first state pension in the 1880s with a] "normal" retirement age of 65, almost no one lived that long, so the German retirement system cost nearly nothing to run. The same was true of Social Security when it started a half century later.


Now that people are routinely living to age 85, it's unreasonable to expect the average person to retire at age 65. If everyone works from 25 to 65, then lives to 85, that means you have two working people supporting each retired person, plus their kids. That isn't going to fly.


8. There are many retirees out there in their 50s with cracked nest eggs. What's your advice for them?


Step one: Spend less and save as much as you can. Step two: Learn how to properly estimate the returns of stocks and bonds, and draw the appropriate conclusions. Step three: Recognize that costs matter. The less you spend on fees, commissions and the hidden trading costs in brokerages and mutual funds, the better off you will be.


Write to Ian McDonald at ian.mcdonald@wsj.com


Updated May 29, 2003 4:15 p.m.




6. Bernstein is right on the money!

Adrian Nenu opines on morninstar.com| 05-30-03 | 05:50 AM

I agree with Bernstein and add that excessive expenses and the lack of objective investor education are two of the leading reasons (along with lower than average future returns) why many will be forced to work longer and harder, save and invest more and despite all efforts, have a less financially secure retirement.


Best wishes, Adrian



Taylor Larimore opines on morninstar.com | 05-30-03 | 11:30 AM


In his first book, "The Intelligent Asset Allocator" Bernstein writes:


"At a minimum a healthy commitment to TIPS in your tax-sheltered account is probably not a bad idea."


In his second book, "The Four Pillars of Investing" Bernstein writes:


"There are TIPS (Treasury Inflation Protected Securities). For those investors who are risk-averse, it's tough to beam them, as they provide a 3.4% real yield."


Thank you and best wishes.




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