By Raymond D. Mignone
After the market’s negative performance in the last few years many investors are hoping that the market will now quickly rebound to pre-2000 levels and that future returns will be relatively high again. But is that a reasonable expectation in light of recent events? And should you base your retirement plan on these assumptions?
Even after considering the recent market declines, several studies are predicting lower-than-average returns for stocks in the future. Most studies are predicting returns of 6 percent to 8 percent annually, assuming a 3 percent inflation rate. These low expectations are based in large part on the fact that market statistics such as price-to-earnings ratios, price-to-book ratios, price-to-sales ratios, and price-to-dividends ratios are still historically high for a bear market.
Only time will tell if these predictions are accurate. However based on recent market performance it may be prudent to assume lower rates of return when designing your investment program for your retirement. It is easier to make adjustments for higher returns than to compensate for lower returns. These lower return expectations may mean that you’ll need to consider other strategies to help your portfolio grow.
If you can’t count on high returns in your portfolio, you should compensate by saving more of your income. If you are still working consider working another year or more than you originally planned to. This will allow you to save more and will postpone the time when you will begin drawing down your nest egg allowing more time for your investments to grow. Another key strategy is to reduce your living expenses for unnecessary expenses such as eating out.
Try to invest in a more tax-efficient manner. Taxes are often a significant investment expense, so that using strategies that defer the payment of taxes can make a substantial difference in your portfolio’s ultimate value. Delay taking withdrawals from IRAs or 401k plans for as long as possible. Emphasize investments that generate capital gains rather than ordinary income. Aggressively harvest tax losses on your current investments to reduce your current income tax and future capital gains. (Yes, there will be future capital gains).
Investigate alternative investments that can produce good total returns uncorrelated to the movements in the overall equity markets. Consider alternative investments such as market neutral or arbitrage funds. Keep in mind that the current market volatility can produce opportunities in closed-end funds due to tax loss selling. These opportunities usually appear during the last quarter of the year but can show up sooner on days the market has large negative swings.
I believe a large part of future returns will come from dividends so try and find investments that are paying a higher than average dividend rate. At least with high dividends you are getting paid to wait for your investments to return to the growth mode.
Keep in mind over the short term the market moves based on overall investor psychology, which is currently extremely pessimistic. This can change very quickly to optimism and allow the market to begin its long-term upward trend. So while you should adjust your overall retirement return rates lower there is just as much chance that over the next few years your returns will surpass your current expectations.
Raymond D. Mignone is a fee-only Certified Financial Planner & Registered Investment Advisor specializing in retirement planning and investment management; he can be reached in Little Neck at 229-2514 or visit www.raymignone.com
