Wade Pfau, PhD, CFA

Wade Pfau, PhD, CFA

In  a recent blog post, Wade Pfau argues that investors with a moderate portfolio should be expecting returns going forward to be around 2% real.  Whether or not you believe his methods, the problem with a 2% return is that it takes an entire career for your money to double at that rate.  That's simply not acceptable for any type of reasonable retirement planning for most Americans.  If returns are really going to be that low, it changes the game completely.

Pfau May Be Too Negative

I run most of my retirement projections off a number that I used to think was fairly conservative – 5% real.  I'm not so sure anymore, especially given historically low bond yields (most of which are negative in real terms.)  It's just hard to average 0% or less with anything and get a decent return over the long run.  Even if stocks achieved their historically average returns (8.6% real according to Pfau) you're not going to get 5% with a 50/50 portfolio.  However, I think Pfau is probably a bit too negative.  Exhibit A?  My own returns.  As regular readers know, I have tracked my own returns meticulously from the day I started investing, March 11th, 2004.  Through both the 2008 crash and the ensuing 4 year bull market, I have achieved an accurate XIRRed, geometric, annualized return of 7.54% per year.  In March 2004 the CPI-U was 187.4 and today it is 230.3.  That annualizes to 2.33%.  7.54% – 2.33% = 5.21% real.  So I'm meeting my projection over my first decade of investing.  At 5%, my money doubles every 14 years, which is much better than every 36 years at 2%.  Of course, I'm carrying what many consider to be a young man's asset allocation, 75% stocks with lots of asset classes considered riskier than US Large Cap Stocks.  Using today's conventional wisdom, carrying that type of portfolio into retirement is a bit foolhardy.

Wade's projections may be overly conservative for another simple reason- investors won't stand for it over the long run.  They'll take their money out of the stock and bond markets and invest it somewhere else if they're not paid adequately for running those risks. Once enough money leaves the markets, yields and expected returns will rise to levels adequate for a reasonable retirement plan.  Of course, there's no evidence of this happening yet.

2% Real Is A Game-Changer

If returns really are 2% real (and don't get me wrong, they are for many Americans already due to inadequate asset allocation, behavioral mistakes, and high investing costs), that's really a game changer.  At a certain level of return, investing in a portfolio of stocks and bonds simply wouldn't be worth it.  It would be time to consider some alternatives.  Let's look at some of them.

Working Into Retirement

Many Americans have found they need to work well into their golden years to have the retirement they want.  This is often due to inadequate savings rates, a poorly thought-out investing plan, or even the loss of an expected pension.  But if your money isn't really growing anyway, it may be easier to live on earned income in retirement instead of portfolio income.  Just half of my current income is more than enough for me to have a very comfortable retirement.  Add in social security and I could probably easily live on what I'd earn working 1/4 time without any significant savings at all.  The problem with this approach, of course, is that some people won't be able to keep working very far at all into retirement.  I'm also well-aware that many professionals are not like emergency docs- they can't just cut their shifts back at will.  It's either work full-time or don't work at all.

Real Estate Investing

Investing in real estate is much more like a second job than investing in paper assets like stocks and bonds (especially when using an easily managed portfolio of index funds.)  But it traditionally has had returns very similar to the stock market.  There are lots of risks, but most of them involve leverage, and it isn't that hard to decrease leverage as you approach retirement to minimize that.  If I really thought my portfolio was only going to earn 2% real going forward, this is probably the first place I'd go to find the returns I need/want.  Thousands, perhaps millions, of people have retired off the income from their investment properties.

Investing In Small Businesses

Along the same lines, when paper assets aren't making much, buying a Chic-Fil-A franchise or a dry cleaner business or a roofing business etc starts looking more attractive.  If I can get a return on my capital of 8% real in a small business, but only 2% real in my portfolio, I'm probably willing to put in that effort and take that risk.

Take More Investment Risk

As yields on fixed income have fallen, this is an approach I have looked at more and more.  Of course, it's wise to remember that more money has been lost chasing yields than in the stock market, but I find it difficult to invest money at 0.02% (the going rate in money market accounts), in moderate length treasuries paying less than the inflation rate, and in TIPS with negative real yields.  The current environment punishes savers and conservative investors, and seems to reward spenders, debtors, and investors willing to take risks.  “Why fight it?” you might wonder.  There are lots of ways to take risks and increase EXPECTED returns.  Instead of investing mostly in US large caps you can invest in small caps, value stocks, microcaps, emerging market stocks or REITs.  Instead of investing in cash, you can invest in precious metals.  Instead of investing in relatively safe, short-term bonds, you can invest in long-term treasuries, corporate bonds, or Peer to Peer Lending.  When making an extra 1-2% on your portfolio is the difference between 2% real and 4% real, some of those risks seem more worthy of consideration to me. In fact, in many ways I'm already doing this with a sliced and diced portfolio and perhaps that's why I haven't had 2% real returns over the last decade.

Don't Invest At All

With anemic interest rates, some may wonder whether to invest at all.  Why not live it up now, spend your whole paycheck, and then just plan on a much decreased standard of living in retirement?  Traditionally, investing is about whether you'd like to spend $100 now or $300 later.  As rates come down the question becomes “$100 now or $100 later?”  At negative real rates, that choice could become “$100 now or $50 later?”  At a certain point for everyone, there's little reason for saving for the future.

Guaranteed Investing Options

The main problem with investing in insurance products like cash value insurance or annuities is that after all the expenses, you end up with low returns.  But if market returns are so low, then these guaranteed, but low, returns don't look so bad.  I recently calculated that the cash value for a whole life insurance policy bought today and held to your life expectancy, had a guaranteed return of 2% (nominal, not real) and a projected return of 4-5%.  Obviously if the markets have poor returns, the returns in the insurance product are going to be much closer to 2% than 4%, and theoretically the company could even go out of business, but even the most ardent whole life insurance foe has to admit that, at a certain point, the guarantee is worth something.


If expected long-term returns are low, it increases the incentive to gamble, whether that involves putting it all on red, buying a lottery ticket, or just taking up the habit of market-timing/short-term trading.  If the chances of you reaching your retirement goals are only 10% due to low expected returns, then perhaps the 48% chance achieved on the roulette table isn't so bad.

Now I'm not making any significant changes to my portfolio based on our low interest rate environment or these rather pessimistic projections of future returns that I'm seeing out there.  This is mostly just a mental exercise.  I'm certainly not recommending you abandon principles that have worked for investors for decades (perhaps even centuries.)  But every now and then, it's fun to think outside the box, even if you don't actually ever leave it.  I do, however, recommend you track your returns over time and adjust your savings rate, the length of your career, and your projected retirement lifestyle accordingly.

If you knew your portfolio returns over your lifetime were going to be 2% after inflation, what changes would you make in your lifestyle and investment strategy?  Comment below!