I’ve spent most of this week working on growth projections for financial plans, and wanted to share some of the results with you for your own planning needs. Those hit most by this will be the people working with financial planners (or brokers) who have been given a growth projection by some fancy software.
Unfortunately, using some of the best solution specific software available, I’ve encountered massive issues that your advisor may have missed. Firstly, sophisticated software tends to run from past performance of the stock/ETF/Fund that you are invested in, or, it runs on the past performance of the benchmark index that it is tracking.
I first noticed the issues when the returns seemed abnormally high for the current environment, where experts such as Bogle, et al are suggesting that a return greater than 5% for the foreseeable future (perhaps the next decade) are going to be hard to achieve. See here from about 2:42
When looking at the outputs from the planning software, I was getting a lot of 7-10% outputs. The reason is that the historical rates (looking back) are often huge by default. For example, TIPs were showing a historical rate of 6%, and short term bonds 3.4%. The numbers are clearly misleading because you can’t earn close to these rates in reality with the current market.
Who should worry?
If you’ve been given a financial plan by someone that shows growth rate, you should double check it. What is the growth rate they are using? What would happen to your plan if you dropped the rate down to 4% or 5% for the next 10 years? Will it survive, or are unrealistically high returns the only way for you to succeed?
Whether you have run your numbers with a professional, or with software, or as a simple compounding calculation, run them again one more time, plan lower.. and if your numbers don’t work, it might be the time to rethink the other things you can control, such as expenses, earning years, and making your investments more efficient.