McKinsey report on diminishing returns

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Robert T
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McKinsey report on diminishing returns

Post by Robert T » Thu Apr 28, 2016 3:48 am

.
http://www.mckinsey.com/industries/priv ... eir-sights
As a result, investment returns over the next 20 years are likely to fall short of the returns of the 1985– 2014 period. In a slow-growth scenario, total real returns from US equities over the next 20 years could average 4 to 5 percent—more than 250 basis points below the 1985–2014 average. Fixed-income real returns could be around 0 to 1 percent, 400 basis points lower or more.
The equity returns in this scenario for Europe are slightly higher than those for the United States. This is because margins for Western European companies are expected to decline at a slower pace than for US firms
Most investors today have lived their entire working lives during this golden era, and a long period of lower returns would require painful adjustments. Individuals would need to save more for retirement, retire later, or reduce consumption during retirement, which could be a further drag on the economy. To make up for a 200 basis point difference in average returns, for instance, a 30-year-old would have to work seven years longer or almost double his or her saving rate.
Start saving early, have an equity orientation (Swensen), diversify globally, keep costs low, have realistic expectations (and reduce 'behavioral mistakes').
.

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Re: McKinsey report on diminishing returns

Post by nisiprius » Thu Apr 28, 2016 5:37 am

Two big questions are 1) whether individuals will act on it, or will they simply ignore or ditch the sources of advice who tell them this and listen to sources of advice (like Dave Ramsey!) who say no problem getting 12%/year?

2) What will institutions, notably pension funds, do? Apparently they have all been baking in unrealistic growth assumptions for a long time. Will they actually scale them back, or will they stick with assumptions that are becoming even more unrealistic, and face the consequences later?
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Re: McKinsey report on diminishing returns

Post by Leesbro63 » Thu Apr 28, 2016 6:57 am

Savers will save. Spenders will spend and investment returns will be what they will be.

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Re: McKinsey report on diminishing returns

Post by Wildebeest » Thu Apr 28, 2016 7:21 am

Thanks Robert T. for posting.

I loved reading the "executive summary" as well as the 60 pages of the the paper ( quite a lot "Getty images" of full page pictures of generic business people). The whole paper was remarkably easy to read for the uninitiated and uneducated ( me).

I may have missed it, but no where was there a justification why comparing the last 30 years with the next 20 years. Who would have thought living through the dot com bubble and the 2007 recession with stock market implosion would be considered the golden age of investing a scant 10 years later. ( I would love to read a similar McKinsey report, but then written in 2009)

Why only do a report on USA and Western Europe? Do not they have clients in Australia, Brazil, Japan or Canada? May be they have created a separate report for China. How does the declining share of the USA and Western Europe in the world economy affect the diminishing returns they outlined ?
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Re: McKinsey report on diminishing returns

Post by BahamaMan » Thu Apr 28, 2016 8:23 am

Whenever I have seen predictions about the markets over my investing life of over 30 years, they are most often completely wrong and usually follow this path.

1.) Prediction is made with almost 100% certainty.
2.) Book usually accompanies prediction written by the same author.
3.) the time period elapses or the markets do something completely different than the prediction.
4.) Author writes a new book explaining what actually happened that prevented his prediction from coming true or that it will come true, it will just take a little longer time period.

Rinse, Repeat........

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Re: McKinsey report on diminishing returns

Post by longinvest » Thu Apr 28, 2016 8:30 am

BahamaMan wrote:Whenever I have seen predictions about the markets over my investing life of over 30 years, they are most often completely wrong and usually follow this path.

1.) Prediction is made with almost 100% certainty.
2.) Book usually accompanies prediction written by the same author.
3.) the time period elapses or the markets do something completely different than the prediction.
4.) Author writes a new book explaining what actually happened that prevented his prediction from coming true or that it will come true, it will just take a little longer time period.

Rinse, Repeat........
+1 :thumbsup
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Re: McKinsey report on diminishing returns

Post by SimpleGift » Thu Apr 28, 2016 8:40 am

Excellent report, thanks for posting it, Robert T. For financial planning, it seems prudent for investors, whether in the accumulation stage or the retirement stage, to use the slow-growth scenario (in orange below) — about 4.5% real return for stocks and 0% real return for bonds.

There actually seems to be a slowly gathering consensus now around expected return numbers in this range, from folks as diverse as Dimson, Marsh and Staunton to Wade Pfau to McKinsey. Forewarned is forearmed for investors!
Last edited by SimpleGift on Thu Apr 28, 2016 8:44 am, edited 2 times in total.

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Re: McKinsey report on diminishing returns

Post by Valuethinker » Thu Apr 28, 2016 8:42 am

nisiprius wrote:Two big questions are 1) whether individuals will act on it, or will they simply ignore or ditch the sources of advice who tell them this and listen to sources of advice (like Dave Ramsey!) who say no problem getting 12%/year?

2) What will institutions, notably pension funds, do? Apparently they have all been baking in unrealistic growth assumptions for a long time. Will they actually scale them back, or will they stick with assumptions that are becoming even more unrealistic, and face the consequences later?
The accounting standards Board and the SEC are much tougher on the private sector than the public, as I understand it.

As a result those remaining private sector DB schemes have at least some chance of having realistic assumptions, and the size of the deficits are quite real.

Whereas apparently with public sector schemes there's been a lot of fiction writing going on. Illinois is in the worst position by most measures (I mean, really, bad). I have my own worries about things like MTA in New York (but have NOT looked at it closely). Illinois used some clever trick of issuing bonds at one interest rate, then investing them at an assumed higher rate (an assumption) in its pension plan. This will end well, I am sure.

As the movie title went "There Will Be Blood". There were excessive pension promises relative to likely returns. Then trustees and managers used excessively high expected rates of return to justify not increasing contributions. At some point the contributors (aka taxpayers) and the beneficiaries are going to have to meet each other-- expect real pain when that happens.

To achieve those, they began to gamble with leveraged investments "alternatives": hedge funds, private equity, infrastructure, real estate. Turns out that that is risky and post fees, may not generate the desired returns (big dispersion of performance depending on manager and when invested). You saw the same sort of thing with people like Harvard Endowment-- they basically seem to have taken a leveraged bet on markets (and Larry Summers is alleged to have more than encouraged that, practically ordered that, a gross breach of governance in the first place), just when the crash hit.

It is a bit like investing in road repair, or the Washington Metro. Washington Post had a long piece on the latter, for 40 years the Board of the transit authority has not wanted to hear bad news. Now there is a risk the whole system could be shut down.

Nobody gets the credit for solving a pension problem (or repairing a Metro tunnel, as opposed to opening a new station) yet, in fact, this is precisely what is needed.

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Re: McKinsey report on diminishing returns

Post by Wildebeest » Thu Apr 28, 2016 9:05 am

Valuethinker wrote: As the movie title went "There Will Be Blood". There were excessive pension promises relative to likely returns. Then trustees and managers used excessively high expected rates of return to justify not increasing contributions. At some point the contributors (aka taxpayers) and the beneficiaries are going to have to meet each other-- expect real pain when that happens.

To achieve those, they began to gamble with leveraged investments "alternatives": hedge funds, private equity, infrastructure, real estate. Turns out that that is risky and post fees, may not generate the desired returns (big dispersion of performance depending on manager and when invested). You saw the same sort of thing with people like Harvard Endowment-- they basically seem to have taken a leveraged bet on markets (and Larry Summers is alleged to have more than encouraged that, practically ordered that, a gross breach of governance in the first place), just when the crash hit.

It is a bit like investing in road repair, or the Washington Metro. Washington Post had a long piece on the latter, for 40 years the Board of the transit authority has not wanted to hear bad news. Now there is a risk the whole system could be shut down.

Nobody gets the credit for solving a pension problem (or repairing a Metro tunnel, as opposed to opening a new station) yet, in fact, this is precisely what is needed.
So true.

As an aside the Vanguard retirement calculator uses the 100 year return for equities and bonds, which to me seems overly optimistic and will give people a false sense of security.
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Re: McKinsey report on diminishing returns

Post by ResearchMed » Thu Apr 28, 2016 9:08 am

Simplegift wrote:Excellent report, thanks for posting it, Robert T. For financial planning, it seems prudent for investors, whether in the accumulation stage or the retirement stage, to use the slow-growth scenario (in orange below) — about 4.5% real return for stocks and 0% real return for bonds.

There actually seems to be a slowly gathering consensus now around expected return numbers in this range, from folks as diverse as Dimson, Marsh and Staunton to Wade Pfau to McKinsey. Forewarned is forearmed for investors!
This chart makes funds like the TIAA Traditional Annuity (group/employer flavor) especially interesting, with the 3% guarantee, and usually a bonus (recently about an additional .75 - 1%).
It's been somewhat higher in the past, but so have other returns in general.

But looking ahead, with this potential in mind, that 3+% for fixed income... very interesting.

Are other funds like "stable value" similarly "guaranteed" (assuming no "end of the world as we know it" scenarios)?

RM
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Re: McKinsey report on diminishing returns

Post by Boglegrappler » Thu Apr 28, 2016 9:12 am

GIven the decline in interest rates that took place over the preceding 30 years, and that decline's effect on valuation and economic activity, reports like this don't surprise me.

It has seemed to me for a number of years now that if equities return somewhere in the upper region of mid-single digits (5-7), we'll be doing very well. If I had to bet, I'd guess low mid-single digits....say 3.5-5 or so. I don't think we'll see near double digit returns anytime soon, especially not "real" returns.

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Re: McKinsey report on diminishing returns

Post by Wagnerjb » Thu Apr 28, 2016 9:13 am

longinvest wrote:
BahamaMan wrote:Whenever I have seen predictions about the markets over my investing life of over 30 years, they are most often completely wrong and usually follow this path.

1.) Prediction is made with almost 100% certainty.
2.) Book usually accompanies prediction written by the same author.
3.) the time period elapses or the markets do something completely different than the prediction.
4.) Author writes a new book explaining what actually happened that prevented his prediction from coming true or that it will come true, it will just take a little longer time period.

Rinse, Repeat........
+1 :thumbsup
+2
Andy

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Re: McKinsey report on diminishing returns

Post by Valuethinker » Thu Apr 28, 2016 9:28 am

ResearchMed wrote:
Simplegift wrote:Excellent report, thanks for posting it, Robert T. For financial planning, it seems prudent for investors, whether in the accumulation stage or the retirement stage, to use the slow-growth scenario (in orange below) — about 4.5% real return for stocks and 0% real return for bonds.

There actually seems to be a slowly gathering consensus now around expected return numbers in this range, from folks as diverse as Dimson, Marsh and Staunton to Wade Pfau to McKinsey. Forewarned is forearmed for investors!
This chart makes funds like the TIAA Traditional Annuity (group/employer flavor) especially interesting, with the 3% guarantee, and usually a bonus (recently about an additional .75 - 1%).
It's been somewhat higher in the past, but so have other returns in general.

But looking ahead, with this potential in mind, that 3+% for fixed income... very interesting.

Are other funds like "stable value" similarly "guaranteed" (assuming no "end of the world as we know it" scenarios)?

RM
The European government bond market returns number looks wrong.

Does it include how many government bond markets dropped to zero in the 20th century? Germany, Austria, Hungary, Czechoslovakia, Russia etc? Spain? Poland? Latvia Lithuania Estonia?

In the UK, gilts lost something like 95% of their real value 1945-2000 (I'd have to check, but on that order). I don't imagine Italy was much different (another defaulter?).

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Re: McKinsey report on diminishing returns

Post by SimpleGift » Thu Apr 28, 2016 9:33 am

BahamaMan wrote:Whenever I have seen predictions about the markets over my investing life of over 30 years, they are most often completely wrong...
Sure, it's smart to be skeptical about projections of future returns. However, it makes a big difference whether they are coming from some yahoo selling a book or newsletter (Dow 36,000!), or whether they're coming from the preeminent financial researchers in the world (McKinsey, Dimson, Marsh and Stuanton, Bank of England, etc.), who are all independently arriving at just about same conclusions about future returns.

Granted, they could still all be wrong — but it's better to be cautious than just rely on historical return averages, in my view.

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Re: McKinsey report on diminishing returns

Post by NOVACPA » Thu Apr 28, 2016 9:47 am

ResearchMed wrote:
Simplegift wrote:Excellent report, thanks for posting it, Robert T. For financial planning, it seems prudent for investors, whether in the accumulation stage or the retirement stage, to use the slow-growth scenario (in orange below) — about 4.5% real return for stocks and 0% real return for bonds.

There actually seems to be a slowly gathering consensus now around expected return numbers in this range, from folks as diverse as Dimson, Marsh and Staunton to Wade Pfau to McKinsey. Forewarned is forearmed for investors!
This chart makes funds like the TIAA Traditional Annuity (group/employer flavor) especially interesting, with the 3% guarantee, and usually a bonus (recently about an additional .75 - 1%).
It's been somewhat higher in the past, but so have other returns in general.

But looking ahead, with this potential in mind, that 3+% for fixed income... very interesting.

Are other funds like "stable value" similarly "guaranteed" (assuming no "end of the world as we know it" scenarios)?

RM
The insurance companies will need to be taking (based on the forecasts) a lot of risk to continue to pay this amount. Since insurance companies have long term liabilities and short term assets, this will be an interesting to see how it plays out. If losses are experienced in the short term, they may be unable to meet their long term liabilities.

This maturity mismatch may be mitigated by reserves that are mandated by regulations. However, it is only mitigated but not eliminated.

I would have serious concerns about the credit risk of "guaranteed" returns in excess of market rates.

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Re: McKinsey report on diminishing returns

Post by rgs92 » Thu Apr 28, 2016 9:53 am

nisiprius wrote:T
2) What will institutions, notably pension funds, do? Apparently they have all been baking in unrealistic growth assumptions for a long time. Will they actually scale them back, or will they stick with assumptions that are becoming even more unrealistic, and face the consequences later?
That's a good point I often wonder about. All these public pension funds seem to assume 7% to 8% a year or more (nominal I guess, not real after inflation).
But still, that seems like fantasy these days even over the long term.

Sure you can't predict returns will drop, but assuming they won't and baking them into your long term plans seems like gambling.

Is that TIAA offering available to the general public? It's seems not, but just asking here.

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Re: McKinsey report on diminishing returns

Post by Quark » Thu Apr 28, 2016 10:10 am

BahamaMan wrote:Whenever I have seen predictions about the markets over my investing life of over 30 years, they are most often completely wrong and usually follow this path.

1.) Prediction is made with almost 100% certainty.
2.) Book usually accompanies prediction written by the same author.
3.) the time period elapses or the markets do something completely different than the prediction.
4.) Author writes a new book explaining what actually happened that prevented his prediction from coming true or that it will come true, it will just take a little longer time period.

Rinse, Repeat........
How do you figure out how much to save and whether you have saved enough to retire without some prediction of market returns?

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Re: McKinsey report on diminishing returns

Post by VA_Gent » Thu Apr 28, 2016 10:13 am

@Quark

Assume zero real growth and save more. Anything above zero is a bonus.
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Re: McKinsey report on diminishing returns

Post by amphora » Thu Apr 28, 2016 10:14 am

Simplegift wrote:Excellent report, thanks for posting it, Robert T. For financial planning, it seems prudent for investors, whether in the accumulation stage or the retirement stage, to use the slow-growth scenario (in orange below) — about 4.5% real return for stocks and 0% real return for bonds.

There actually seems to be a slowly gathering consensus now around expected return numbers in this range, from folks as diverse as Dimson, Marsh and Staunton to Wade Pfau to McKinsey. Forewarned is forearmed for investors!
Like all reports, it's worth taking with a grain of salt. This seems to be the consensus and it seems credible because it doesn't propose some magic investment that will outperform the markets. The only solution is to save more. :|

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Re: McKinsey report on diminishing returns

Post by Angst » Thu Apr 28, 2016 10:19 am

I think all reasonable and intelligent investors think about what the future potentially holds for them, particularly in context with their personal past and present situations and the overall investing environment in general. Anyone who doesn't is hopefully having their investment affairs managed by some fiduciary who does!

I thought that this paper was well-written and balanced. There is a reasonable space somewhere between the extremes of the "Chicken Little" attitudes some posts in this thread reflexively refer to and the "Nothing but Blue Skies" sensibility of the likes of Dave Ramsey, and this interesting report clearly falls into that reasonable middle ground. Thank you Robert T for posting the link.

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Re: McKinsey report on diminishing returns

Post by Hallman » Thu Apr 28, 2016 10:36 am

I'd be very happy with the returns projected for equities, even for the slow growth scenario.

Reports like this usually say that saving rates need to go up, but they might very well might have the opposite effect. People are hardly saving when they think equities return a fairly steady 12% annualized (from my experience at least). If you tell them they should be hoping for 5% real before taxes and fees, with high volatility and uncertainty, I think many people would give up the stock market and save less than today.

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Re: McKinsey report on diminishing returns

Post by 2015 » Thu Apr 28, 2016 10:38 am

Wagnerjb wrote:
longinvest wrote:
BahamaMan wrote:Whenever I have seen predictions about the markets over my investing life of over 30 years, they are most often completely wrong and usually follow this path.

1.) Prediction is made with almost 100% certainty.
2.) Book usually accompanies prediction written by the same author.
3.) the time period elapses or the markets do something completely different than the prediction.
4.) Author writes a new book explaining what actually happened that prevented his prediction from coming true or that it will come true, it will just take a little longer time period.

Rinse, Repeat........
+1 :thumbsup
+2
+3 (and thank you for putting it so well).

But...but...but this time the soothsayer is the very well respected McKinsey people, and what about the "consensus" of all the other astrological forecasters mentioned above of (Pfau, et al), I mean it really is different this time, isn't it, so this time the witch doctors' chicken bones really do predict the future, don't they? So we can just forget all about authority bias at work. Again. Right?

http://www.amazon.com/Myth-Free-Will-Re ... 714&sr=1-1
Authority Bias: The tendency to take on the opinion of someone who's seen as an authority on a subject.

First, we over-value the opinion of mommy and daddy, then our peers, our teachers and our personal god(s). Later on, it's experts on stuff: art critics, pundits, doctors, repair people, and so on.

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Re: McKinsey report on diminishing returns

Post by SimpleGift » Thu Apr 28, 2016 10:59 am

One way to assess and check on the experts' opinion is to look at what the market is currently forecasting:
  • • Earnings Yield of S&P 500 (reciprocal of P/E, or 100/26.32): 3.8%
    • Yield of 20-year TIPS Bond: 0.6%
It seems the experts, plus the consensus of all the market participants on the planet, feel about the same way — real stock and bond returns over the next twenty years are expected be much lower than their historical averages.
Last edited by SimpleGift on Thu Apr 28, 2016 2:05 pm, edited 1 time in total.

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Re: McKinsey report on diminishing returns

Post by AnonJohn » Thu Apr 28, 2016 11:24 am

I, for one, look forward to these higher returns! As a GenX-er, I started saving for retirement at the wrong time in the late 90's. My inflation adjusted, time dependent, lifetime return is 4% over a ~17 year period.

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Re: McKinsey report on diminishing returns

Post by BahamaMan » Thu Apr 28, 2016 11:35 am

Quark wrote:How do you figure out how much to save and whether you have saved enough to retire without some prediction of market returns?
I never thought about predicting future returns.

I saved as much as I could, and I looked at past Market history to see how I would have fared based on my Asset Allocation.

I am now retired and using VPW as a Withdrawal Method. It cannot fail, no matter what the markets do.

Stay the course, as there is nothing more I can do.

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Re: McKinsey report on diminishing returns

Post by Rodc » Thu Apr 28, 2016 11:36 am

Simplegift wrote:Excellent report, thanks for posting it, Robert T. For financial planning, it seems prudent for investors, whether in the accumulation stage or the retirement stage, to use the slow-growth scenario (in orange below) — about 4.5% real return for stocks and 0% real return for bonds.

There actually seems to be a slowly gathering consensus now around expected return numbers in this range, from folks as diverse as Dimson, Marsh and Staunton to Wade Pfau to McKinsey. Forewarned is forearmed for investors!
Since low but not horrible returns like these can happen at any time (or over any period), predicted or not, it seems one should always plan for these sorts of returns. If you get better returns great - you can retire earlier, send the kids to a more expensive schools, or retire to a higher lifestyle or whatever.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Re: McKinsey report on diminishing returns

Post by Rodc » Thu Apr 28, 2016 11:42 am

BahamaMan wrote:
Quark wrote:How do you figure out how much to save and whether you have saved enough to retire without some prediction of market returns?
I never thought about predicting future returns.

I saved as much as I could, and I looked at past Market history to see how I would have fared based on my Asset Allocation.

I am now retired and using VPW as a Withdrawal Method. It cannot fail, no matter what the markets do.

Stay the course, as there is nothing more I can do.
Early in life there are too many unknowns for any prediction to be meaningful. Rather assume the future will look more or less like a low return but not disastrous past and income will go up somewhat and move forward. Which really just means save around 20% of income, or more if you want to shoot for early retirement. You can call that a "prediction" if you want, but I would call that a rough planning assumption.

You can course adjust as you go (just as you will with marriage, kids, career, health and all sorts of things you can't predict very well).

As you approach retirement simply adjust expectations to meet reality and continue to plan for lowish returns. Keep fixed expenses low. Make sure you can be flexible (or better start annuitizing, though that only helps on the income side not the expense side where things like unexpected health expenses can get you)

One can of course use whatever fancy calculator one wants (Lord knows I have written and used enough of them) to generate however many meaningless non-significant digits of false accuracy floats one's boat, but one should not confuse that with doing some actually useful. :)
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Re: McKinsey report on diminishing returns

Post by lack_ey » Thu Apr 28, 2016 11:48 am

You also need to account for the possibility of lower returns than stipulated here. The uncertainty cuts both ways. It could be a lot better than we think too, but generally you don't need as much planning for that scenario.

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Re: McKinsey report on diminishing returns

Post by garlandwhizzer » Thu Apr 28, 2016 12:08 pm

Robert T wrote:
Start saving early, have an equity orientation (Swensen), diversify globally, keep costs low, have realistic expectations (and reduce 'behavioral mistakes').
Great post, Robert T. This is in my opinion the take home message. Given current circumstances (as well as any circumstances anytime) this is good sound advice. As Simplegift has pointed out, looking at today's market fundamentals and macroeconomic picture most respected economic forecasters have come to similar conclusions about lower returns on all investments going forward in developed markets. While forecasting the economic future is fraught with inaccuracy in general I do believe it is wise not to count on a rosy future of returns using long term historical measures in terms of retirement planning. Instead it's probably better to give some credence to these projections of lower returns rather than to accept as gospel what we wish to be true (historical returns) in financial planning. In order to plan effectively for the future the first step is to start out with what appear to be reasonable expectations based on current data rather than hope. If you turn out to be overly pessimistic the problem is you wind up with too much money, a far better situation than if overly optimistic projections leave you old and broke.

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Re: McKinsey report on diminishing returns

Post by FrogPrince » Thu Apr 28, 2016 12:56 pm

Robert T wrote:.
Most investors today have lived their entire working lives during this golden era, and a long period of lower returns would require painful adjustments. Individuals would need to save more for retirement, retire later, or reduce consumption during retirement, which could be a further drag on the economy. To make up for a 200 basis point difference in average returns, for instance, a 30-year-old would have to work seven years longer or almost double his or her saving rate.
Start saving early, have an equity orientation (Swensen), diversify globally, keep costs low, have realistic expectations (and reduce 'behavioral mistakes').
.
Thanks for posting the gist of the paper. If the difference is retiring 7 years later, with people living longer these days, it's not the end of the world, and imo hardly qualifies as a 'painful adjustment'.

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Re: McKinsey report on diminishing returns

Post by Aptenodytes » Thu Apr 28, 2016 1:08 pm

rgs92 wrote:
nisiprius wrote:T
2) What will institutions, notably pension funds, do? Apparently they have all been baking in unrealistic growth assumptions for a long time. Will they actually scale them back, or will they stick with assumptions that are becoming even more unrealistic, and face the consequences later?
That's a good point I often wonder about. All these public pension funds seem to assume 7% to 8% a year or more (nominal I guess, not real after inflation).
But still, that seems like fantasy these days even over the long term.

Sure you can't predict returns will drop, but assuming they won't and baking them into your long term plans seems like gambling.

Is that TIAA offering available to the general public? It's seems not, but just asking here.
Larry Summers recently argued that the Harvard endowment should lower its payout rate in light of the trends high quality lighted in the McKinsey report. Sorry can't easily paste link while on this bumpy bus.

I see TRAD as a short term arbitrage opportunity but it is bound to pass at some point. I buy all I can each month for the time being.

The high yield TRAD vintages are not open to the general public.

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Re: McKinsey report on diminishing returns

Post by Quark » Thu Apr 28, 2016 1:27 pm

BahamaMan wrote:
Quark wrote:How do you figure out how much to save and whether you have saved enough to retire without some prediction of market returns?
I never thought about predicting future returns.

I saved as much as I could, and I looked at past Market history to see how I would have fared based on my Asset Allocation.

I am now retired and using VPW as a Withdrawal Method. It cannot fail, no matter what the markets do.

Stay the course, as there is nothing more I can do.
"saved as much as I could"? Presumably that means save as much as you could consistent with some lifestyle, rather than living on the street, etc. If so, how did you decide how much you could spend (so that you were comfortable you were saving enough)?

VPW can't fail, but it can lead to wide fluctuations in income or, especially if you haven't saved enough, not having enough to support the lifestyle you want.

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Re: McKinsey report on diminishing returns

Post by SimpleGift » Thu Apr 28, 2016 1:29 pm

It occurs to me that many folks who have been investing and accumulating over the last 30+ years don't really appreciate how exceptional their asset returns have been, especially on the bond side — over 6% real return on bonds since 1980! (chart below). For added perspective on the lower returns expected in the decades to come, below are projections from Dimson, Marsh and Staunton in their 2013 Yearbook — which are right in line with the McKinsey report and the current expectations of the stock and bond markets.
Dimson, Marsh and Staunton wrote:The high equity returns of the second half of the 20th century were not normal; nor were the high bond returns of the last 30 years; and nor was the high real interest rate since 1980. While these periods may have conditioned our expectations, they were exceptional.
With real stock and bond returns both over 6% since 1980, one didn't need to do much financial planning or thinking ahead!
Last edited by SimpleGift on Thu Apr 28, 2016 5:15 pm, edited 3 times in total.

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Re: McKinsey report on diminishing returns

Post by Quark » Thu Apr 28, 2016 1:35 pm

Rodc wrote:...Early in life there are too many unknowns for any prediction to be meaningful. Rather assume the future will look more or less like a low return but not disastrous past and income will go up somewhat and move forward. Which really just means save around 20% of income, or more if you want to shoot for early retirement. You can call that a "prediction" if you want, but I would call that a rough planning assumption.

You can course adjust as you go (just as you will with marriage, kids, career, health and all sorts of things you can't predict very well).

As you approach retirement simply adjust expectations to meet reality and continue to plan for lowish returns. Keep fixed expenses low. Make sure you can be flexible (or better start annuitizing, though that only helps on the income side not the expense side where things like unexpected health expenses can get you)

One can of course use whatever fancy calculator one wants (Lord knows I have written and used enough of them) to generate however many meaningless non-significant digits of false accuracy floats one's boat, but one should not confuse that with doing some actually useful. :)
Save 20% is probably good advice. I would call that a "prediction"; the genesis of 20% likely implicitly incorporated some predicted rate of return.

Adjusting as you go requires you to know if you are on track. You could base it on having a 4% withdrawal rate goal, but that again implies some predicted rate of return.

Annuitizing may be a good course (and annuity returns can be a way to get a forecast), but it doesn't seem very popular.

Expenses could well be as unpredictable as income.

I doubt we can predict returns more accurately than a 5-10 percentage point margin of error. Most people probably just rely on rules of thumb or the even looser "save as much as I can". On the other hand, most people don't have significant savings and rely on Social Security for retirement income.

Rough rules of thumb or the like may well be the best we can do. To the extent those rules of thumb referenced as unusual in simplegift's immediately preceding post, then Social Security becomes even more important.
Last edited by Quark on Thu Apr 28, 2016 1:37 pm, edited 1 time in total.

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Re: McKinsey report on diminishing returns

Post by Solo Prosperity » Thu Apr 28, 2016 1:35 pm

Could always go 60 EM stock and 40 EM bonds :beer

I kid. But I did find it interesting that this report left out the EM data and discussion since if you are going to look at long-term value and returns, leaving out such a massive piece like EM countries considering it makes up roughly 40% of global GDP (basically the U.S. and Europe combined) roughly 15% of global fixed income and EM countries are trading around an average CAPE of 13.4 while Global Developed is around 17.7 and the U.S is around 26 currently.

I agree with Swenson that diversifying globally is very important (although in full disclosure I have 0% allocation for Foreign bonds, developed or EM, I do however have about 40% of equities in Foreign funds) since just as I cannot predict which stocks in the U.S. will outperform consistently, I cannot predict which countries, regions and economies will outperform consistently.

My money is on EM though for the next decade or two. We can make fun of me if this forum is still here in 10 and 20 years =)
Last edited by Solo Prosperity on Thu Apr 28, 2016 1:38 pm, edited 1 time in total.

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Re: McKinsey report on diminishing returns

Post by longinvest » Thu Apr 28, 2016 1:36 pm

Quark wrote:"saved as much as I could"? Presumably that means save as much as you could consistent with some lifestyle, rather than living on the street, etc. If so, how did you decide how much you could spend (so that you were comfortable you were saving enough)?
I agree with BahamaMan's approach. My wife and I just use some common sense to save as much as possible, without depriving ourselves. If, at some point, we want to spend some additional money on something, we discuss it, and if we feel that it will enhance our well being and we can afford it, we do it.
Quark wrote:VPW can't fail, but it can lead to wide fluctuations in income or, especially if you haven't saved enough, not having enough to support the lifestyle you want.
Neither VPW nor any other withdrawal method can replace insufficient savings. But, delaying retirement to save more can solve this problem.

Of course, we plan to have some lifelong non-portfolio income, too, in the form of government programs (OAS and QPP, Canadian equivalent of Social Security) and a pension. Those who don't have a pension can buy a (joint, for couples) inflation-indexed Single Premium Immediate Annuity (SPIA).
Last edited by longinvest on Thu Apr 28, 2016 1:41 pm, edited 1 time in total.
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Re: McKinsey report on diminishing returns

Post by Rodc » Thu Apr 28, 2016 1:40 pm

Save 20% is probably good advice. I would call that a "prediction"; the genesis of 20% likely implicitly incorporated some predicted rate of return
I would say no, but it depends on how one wants to define "prediction". It is simply a historical fact that saving 20% starting sometime in your 20s has done ok - sometimes really well and sometimes not great, but good enough if one kept fixed costs down. It is not based on any specific expectation of returns, though is a general expectation that the future will hopefully at least have a passing resemblance to the past. If you want to define that to be a prediction that is fine, but I note it is such a weak definition that it does not mean very much. I note I do not really predict the future will look like the past so much as hope this is true more or less. Again, not so much a prediction as a planning assumption that may or may not be correct.
Expenses could well be as unpredictable as income.
Absolutely which is why worrying about any specific prediction is likely not very useful.
Rough rules of thumb or the like may well be the best we can do.
Right and especially early on. I personally would not call that using the term "prediction", but if you want to that is fine by me.

At that point we are not arguing substance but definitions.

ETA: Looking on-line it seems that definitions of what prediction means really does include what I would think of as pretty flimsy and not very useful statements about the future. Almost any statement about the future counts, so whether I like it or not, or think it meaningful or not, I guess I make predictions. :)
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Re: McKinsey report on diminishing returns

Post by BahamaMan » Thu Apr 28, 2016 1:53 pm

Quark wrote: VPW can't fail, but it can lead to wide fluctuations in income or, especially if you haven't saved enough, not having enough to support the lifestyle you want.
VPW won't lead to wide fluctuations income in most cases. In my case I have a Conservation Asset Allocation, and am Delaying S.S. to age 70. And if markets were bad enough in the future that VPW actually did result in 'Wide Fluctuations of income", any other withdrawal method would completely fail.
Last edited by BahamaMan on Thu Apr 28, 2016 1:55 pm, edited 1 time in total.

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Re: McKinsey report on diminishing returns

Post by Chadnudj » Thu Apr 28, 2016 1:54 pm

Simplegift wrote:Excellent report, thanks for posting it, Robert T. For financial planning, it seems prudent for investors, whether in the accumulation stage or the retirement stage, to use the slow-growth scenario (in orange below) — about 4.5% real return for stocks and 0% real return for bonds.

There actually seems to be a slowly gathering consensus now around expected return numbers in this range, from folks as diverse as Dimson, Marsh and Staunton to Wade Pfau to McKinsey. Forewarned is forearmed for investors!
Or, in the alternative:

Now that everyone is coming to this consensus, it's almost assuredly wrong.

I'm predicting the next 20 years will probably very nearly match the real, long-term returns on average across every category. I'll probably be closer to correct than at least 50% of everyone else.

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Re: McKinsey report on diminishing returns

Post by tyc » Thu Apr 28, 2016 2:41 pm

Why call the future return the "Expected Return" when the future is so uncertain!!!

Good luck in focusing the expected (UNEXPECTED) return.

I'll be spending my time in figuring out my "Expected" savings.

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Re: McKinsey report on diminishing returns

Post by Solo Prosperity » Thu Apr 28, 2016 2:50 pm

tyc wrote:Why call the future return the "Expected Return" when the future is so uncertain!!!

Good luck in focusing the expected (UNEXPECTED) return.

I'll be spending my time in figuring out my "Expected" savings.
Not sure how you can figure out your "Expected" savings without at least some rational or guesstimate of expected or unexpected returns.

Unless you don't plan on factoring in any rate of return on your money and just want to save a ton and plan to live off of purely savings (0% growth) this will work.

I get what your saying. The savings component is more important than the expected returns component...but, you have to at least have some thought about returns.

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Re: McKinsey report on diminishing returns

Post by longinvest » Thu Apr 28, 2016 3:13 pm

QuietWealth wrote:I get what your saying. The savings component is more important than the expected returns component...but, you have to at least have some thought about returns.
QuietWealth,

BahamaMan and Rodc have explained in earlier posts, on this thread, how one does not need to have "some thought about returns" to save for retirement.

Personally, I have no idea what future returns will be, but that does not prevent me from saving for retirement. I don't save so much as to live as a pauper, but I'm confident that I'm saving enough. I just don't know exactly when I'll be able to retire. It might be earlier or later; it all depends on too many unknowns about the future (markets, personal preferences, spending needs).
Last edited by longinvest on Thu Apr 28, 2016 3:13 pm, edited 1 time in total.
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Re: McKinsey report on diminishing returns

Post by lack_ey » Thu Apr 28, 2016 3:13 pm

Chadnudj wrote:
Simplegift wrote:Excellent report, thanks for posting it, Robert T. For financial planning, it seems prudent for investors, whether in the accumulation stage or the retirement stage, to use the slow-growth scenario (in orange below) — about 4.5% real return for stocks and 0% real return for bonds.

There actually seems to be a slowly gathering consensus now around expected return numbers in this range, from folks as diverse as Dimson, Marsh and Staunton to Wade Pfau to McKinsey. Forewarned is forearmed for investors!
Or, in the alternative:

Now that everyone is coming to this consensus, it's almost assuredly wrong.

I'm predicting the next 20 years will probably very nearly match the real, long-term returns on average across every category. I'll probably be closer to correct than at least 50% of everyone else.
Even bonds, too?

Which averages over which datasets are you looking at?


longinvest wrote:
QuietWealth wrote:I get what your saying. The savings component is more important than the expected returns component...but, you have to at least have some thought about returns.
QuietWealth,

BahamaMan and Rodc have explained in earlier posts, on this thread, how one does not need to have "some thought about returns" to save for retirement.

Personally, I have no idea what future returns will be, but that does not prevent me from saving for retirement. I don't save so much as to live as a pauper, but I'm confident that I'm saving enough. I just don't know exactly when I'll be able to retire. It might be earlier or later; it all depends on too many unknowns about the future (markets, personal preferences, spending needs).
How do you know returns aren't -50% a year, or 300%? You must have some idea.

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Re: McKinsey report on diminishing returns

Post by longinvest » Thu Apr 28, 2016 3:17 pm

lack_ey wrote:How do you know returns aren't -50% a year, or 300%? You must have some idea.
No, I don't. That does not prevent me from having some common sense and put aside money for the future, instead of spending it all today. :happy

Actually, I have a healthy allocation to bonds, in my portfolio. I know that bonds won't return -50% or 300% nominal next year (it's a mathematical near certainty). But, I really have no idea what my stock allocation could do. I don't know what inflation will do, either, but the Bank of Canada's monetary policy is based on a target of 2%, the mid-point of a 1% to 3% range. It has succeeded to keep within this range and near target ever since it has adopted this policy in 1991.
Last edited by longinvest on Thu Apr 28, 2016 3:25 pm, edited 1 time in total.
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Re: McKinsey report on diminishing returns

Post by lack_ey » Thu Apr 28, 2016 3:25 pm

longinvest wrote:
lack_ey wrote:How do you know returns aren't -50% a year, or 300%? You must have some idea.
No, I don't. That does not prevent me from having some common sense and put aside money for the future, instead of spending it all today. :happy

Actually, I have a healthy allocation to bonds, in my portfolio. I know that bonds won't return -50% or 300% next year (it's a mathematical near certainty). But, I really have no idea what my stock allocation could do.
So how do you determine when you can retire? Will you convert everything to fixed income and/or annuities when that happens? If not, what do you think or do about the stocks?

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Re: McKinsey report on diminishing returns

Post by Solo Prosperity » Thu Apr 28, 2016 3:27 pm

longinvest wrote: QuietWealth,

BahamaMan and Rodc have explained in earlier posts, on this thread, how one does not need to have "some thought about returns" to save for retirement.

Personally, I have no idea what future returns will be, but that does not prevent me from saving for retirement. I don't save so much as to live as a pauper, but I'm confident that I'm saving enough. I just don't know exactly when I'll be able to retire. It might be earlier or later; it all depends on too many unknowns about the future (markets, personal preferences, spending needs).
BahamaMan:
I saved as much as I could, and I looked at past Market history to see how I would have fared based on my Asset Allocation.
Rodc:
Since low but not horrible returns like these can happen at any time (or over any period), predicted or not, it seems one should always plan for these sorts of returns.
Early in life there are too many unknowns for any prediction to be meaningful. Rather assume the future will look more or less like a low return but not disastrous past and income will go up somewhat and move forward. Which really just means save around 20% of income, or more if you want to shoot for early retirement. You can call that a "prediction" if you want, but I would call that a rough planning assumption.
I don't think you need to forecast expected returns for every 5 years or something fancy, but again, you need somewhat of a baseline assumption to help figure out a part of your "savings rate". Use the full market history, use the last 40 years, use CAPE, I don't really care, but you need some assumption.

Saying you don't have some expected idea of future returns (low, high, average, whatever) that has some affect (even small) on your expected savings rate seems somewhat misguided to me.

It doesn't have to be right or even that precise, but I am sure you have some assumption of future returns baked into your head for your portfolio...we are all human.

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Re: McKinsey report on diminishing returns

Post by longinvest » Thu Apr 28, 2016 3:29 pm

lack_ey wrote:So how do you determine when you can retire? Will you convert everything to fixed income when that happens?
I'll have lifelong non-portfolio base income in the form of OAS (federal program), QPP (provincial program), and a pension. I might consider buying an inflation-indexed SPIA if I feel the need for it. I'll also have a big portfolio with a healthy allocation to bonds, and I'll use VPW as guide for taking money out.

So, to evaluate when I can retire, I just need to make a calculation to estimate how much I'll get in base income (and how much money I need to bridge the delay, if any, between retirement and the start of OAS/QPP), look at my portfolio, and decide appropriately. I know that the bonds, in my portfolio, won't melt. If they do, there will be far more serious troubles in society than a worry about the value of financial assets...
Last edited by longinvest on Thu Apr 28, 2016 3:37 pm, edited 3 times in total.
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Re: McKinsey report on diminishing returns

Post by Rodc » Thu Apr 28, 2016 3:30 pm

How do you know returns aren't -50% a year, or 300%? You must have some idea.
Well with a compound growth rate of 300% over a life time the money supply would have to grow to be near infinite. So that is highly unlikely at least in real terms (see Wiemar Germany).

Unfortunately -50%, indeed -100% could happen, but that means the entire world economy blew up and everything is beyond my control to deal with, so I just don't worry, much less try to plan for that.

I make a plan that has some reasonable chance of working if we get anything like what has been seen outside of countries losing world wars and the like, and outside of catastrophic personal disaster (someone sues me for $100M and wins).

This was especially true when I was younger and everything was unknown. Now a few years from retirement things look pretty good. What I might have for retirement income is driven far more by how many years I might still work than what return I am likely to get. Every year I retire before pensions and SS start I lose a year of income, lose a year of savings, lose a year of growth, and have to take a year of full income from savings (after pension I just need to take a small amount out of savings to cover what pensions and SS do not). The drawdown to cover the gap to pensions and SS makes a really big difference in likely retirement income.

Rather than make any specific prediction about the future returns I'll watch what returns I get and I can spend more in good years and less or nothing in bad years.
Last edited by Rodc on Thu Apr 28, 2016 3:41 pm, edited 1 time in total.
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Re: McKinsey report on diminishing returns

Post by Rodc » Thu Apr 28, 2016 3:38 pm

I don't think you need to forecast expected returns for every 5 years or something fancy, but again, you need somewhat of a baseline assumption to help figure out a part of your "savings rate". Use the full market history, use the last 40 years, use CAPE, I don't really care, but you need some assumption.
Some understanding of history and basic market theory is helpful. It is good to know that it is unlikely that stock returns will average 20% over your lifetime. But only a few percent is certainly something that might happen. (thinking of a stock bond portfolio).

It is good to know that historically if you start in your 20s something like saving 15% has worked well for many people and more increases the odds (especially if you get forced into early retirement against your will). This is where I started. I knew very little but somehow knew 15% was a middling number, and I knew that stocks were more risky and had higher expected returns than bonds (but had no sense of what the numbers might be). I was young and figured more risk was ok, but 100% stocks just seemed high, so I started at 70/30 and stayed there many years just putting away money every pay check. Later as income went up I increased to the max allowed in my 401K (plus wife and I have pensions).

Worrying too much about precision or absolute safety early on though is wasted effort.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Re: McKinsey report on diminishing returns

Post by longinvest » Thu Apr 28, 2016 3:47 pm

lack_ey wrote:So how do you determine when you can retire? Will you convert everything to fixed income and/or annuities when that happens? If not, what do you think or do about the stocks?
Lack_ey,

Let me add this to my earlier answer.

Actually, any Canadian could "retire" today, if he/she wanted, and live very frugally on government subsidies; some do that, actually, but it's usually not by choice, and it's nothing to aspire to! Of course, I have higher aspirations. But, fundamentally, we're just discussing relative levels of wealth in retirement, here. :wink:

We're lucky to live in wealthy societies.
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