As the value of shares in the Thrift Savings Plan’s stock-based C, S and I Funds has fallen over the past year, so too have more than a few expectations for comfortable retirement in the near future.
Lower portfolio values generally equal lower confidence when it comes to funding retirement income beyond guaranteed pension benefits. Whether you’re acutely aware of it or not, the fact is that the probability of realizing your retirement dreams is rising and falling all the time along with the markets. But do your retirement dreams really blink on and off from one day, week or month to the next? Every time the markets fall, do you have to give up your retirement dreams, and then cross your fingers and hope that the vagaries of the markets will give them back to you?
Well, you might if you haven’t planned properly. Always remember that while your ability to control your investment results is limited, your opportunity to plan ahead is not.
When the stock markets were consistently rising during the late 1990s and from 2003 through 2007, you felt great about your portfolio and your retirement plan. As your portfolio grew, so did your expectations for the future. More money now means more money later – in the form of retirement income – right?
Not so fast. As the markets were doing what you thought you wanted them to do, you might have missed that something less obvious was happening. During the late 1990s and the five years preceding the current bear market, investments in the stock markets grew at rates that were significantly higher than the averages for the past 50, 80 or 100 years. In other words, the markets had gotten ahead of themselves, and so had your shares in the C, S and I funds.
An investment in the I Fund more than doubled during the period between the beginning of 2003 and the end of 2007 – experiencing an average annual growth rate of more than 20 percent per year. But as the values in these funds grew, the prospects for their future growth diminished. Any optimism based on your newfound wealth should have been tempered by concern over the fact that the expected rate of return for that wealth, going forward, was reduced below what it was before the growth.
The expected rate of return for the C Fund, for example, would reasonably have been lower in September 2007, when the S&P 500 index, on which the fund’s performance is based, was near 1,500, than it is now when the index is hovering around 900.
The expected rate of return for the C Fund, for example, would reasonably have been lower in September 2007, when the S&P 500 index, on which the fund’s performance is based, was near 1,500, than it is now when the index is hovering around 900.
Suppose, for example, the average rate of return for an investment over the past 100 years has been 10 percent per year. It might be reasonable to expect this rate of return going forward from the same type of investment, but only if the current value of that investment is near the average value of that investment. If the market is overvalued relative to what should be expected, then the expected rate of return used in your planning should be something less than 10 percent. Likewise, when the current value is lower than expected, the expected rate of return can be something higher than 10 percent.
While the analysis necessary to determine what the current “fair value” of the market and expected rate of return should be is beyond the scope of this discussion, it is important to realize that if your investment portfolio has lost value as a result of the bear market, the damage done to your retirement plan is being offset, at least in part, by a corresponding rise in expectations for future returns.
If investment returns are the only variable, a plan that worked in 2006 should still work today. Your portfolio’s value may have been higher in 2006 than it is today, but the expected rate of return for a similar asset allocation should be higher today than it was then. To put things in perspective, over 30 years that 10 percent rate of return I mentioned earlier will have to rise to 11.7 percent to compensate for a 20 percent loss in your portfolio’s value. This performance improvement is well within the historical limits for variation in 30-year rates of return for the stock markets.
Written by Mike Miles
For the Federal Times
Publication December 22, 2008