Retirement Planning Is Not an Exact Science

June 7, 2018

How do you figure out how much to save for retirement?

Financial consultants use a number of assumptions to generate projections in a retirement plan. One of these assumptions is the rate of return on your investments. When creating your financial plan, it’s better to be on the conservative side when projecting longer-term returns so that you’re not left in a shortfall position.

During the bull market of the 1990s, it was common for investors to expect double-digit returns, but projecting double digits well into the future would have been unwise.

Past performance is often used to come up with rate of return projections. But when you look at historical returns for both the equity and bond markets, you can see that annual returns have been trending downward recently (see graph).

For instance, in the 90 years between 1926 and 2015, the average annual compound return for stocks was 10%. Over the past 20 years, the average was 8.2% and over the past 10 years, it was 7.3%.1

reduced returns graph_e

The point is that it’s not realistic to use an average return from a 90-year period in which, once you've averaged out the highs and lows, your return is still 10%.

Assumptions used for retirement planning

Looking forward, what rates of return should you use when making retirement projections?

Considering long-term historical averages, projections of slower economic growth, and a sustained low interest rate environment, MD currently uses 4% to 5% as the expected long-term rate of return for a balanced portfolio (60% equity, 40% fixed income).

Let’s look at an example and see how retirement planning would work for this physician.

Dr. Taylor is a 50-year-old ophthalmologist who plans to retire in 15 years. He currently has assets of $1.2 million (not including real estate) and is wondering if he is on track to meet his retirement goals.

Here are the basic assumptions that financial consultants use to generate projections: 

  • Rates of return

    If Dr. Taylor’s assets are at $1.2 million now, how will they grow over the next 15 years? Using 4.5% (compounded annually) as the expected rate of return, Dr. Taylor’s balanced portfolio is projected to grow to $2.32 million by the time he retires, before fees and taxes. 

    MD arrives at an expected rate of return based on historical data, current market conditions, and future outlook. The assumptions for rate of return are reviewed regularly and updated as warranted. Adjustments to these assumptions will change the outcome.


  • Savings pattern

    Investment growth is one thing, but Dr. Taylor also plans to continue saving. Like most physicians, he doesn’t have a private pension plan, so by saving $30,000 each year, he will help build his retirement fund. Over 15 years, based on the same 4.5% expected rate of return, that’s an additional $651,600—for a total of $2.97 million. 

    If Dr. Taylor does not save this amount on an ongoing basis or if he decides to withdraw money for other purposes, the outcome will change and the plan will need to be revisited to make the appropriate adjustments.


  • Government pensions

    At retirement, Dr. Taylor may also be eligible for Old Age Security and the Canada Pension Plan. (If he lived in Quebec, he might be eligible for the Quebec Pension Plan.) Together, the OAS and CPP currently pay an average of $14,400 per year at age 65 (up to a maximum of almost $20,000).

    But how do you know what these amounts will be in the future? Financial consultants come up with estimates based on inflation assumptions. While actual inflation is based on movements in the consumer price index, financial consultants rely on assumptions about inflation over the long term.


  • Inflation

    Let’s say Dr. Taylor would like a retirement income of $100,000 a year (in today’s dollars). In 15 years, the equivalent retirement income would be $134,600, once you factor in a 2% annual inflation rate. That 2% rate is an inflation assumption, but over the long term the actual inflation number can vary.


  • Life expectancy

    Financial consultants use average life expectancy rates to set assumptions for how long a client might live. To help ensure Dr. Taylor doesn’t outlive his money, his financial plan assumes that he will live to at least age 95. Because some people will live much longer than the average life expectancy, it may make sense to create a plan that covers this possibility.


  • Withdrawal rate

    Assuming Dr. Taylor lives to age 95, his investment portfolio would need to last 30 years (age 65 to 95). At a withdrawal rate of 4%, Dr. Taylor should be able to maintain his capital to the end of his life. Any changes to the withdrawals taken in retirement will need to be factored into the assumptions, and the plan updated accordingly. This may include withdrawals for vacations, home repairs, gifting to beneficiaries, and so on. 

Financial plans need regular checkups

Your MD Advisor can estimate your retirement income using assumptions like the ones above. But these assumptions may need to be refined over time.

If your retirement plan hasn’t been reviewed in the past year, check in with your MD Advisor to see if you need to make any changes, such as saving more or saving longer for your retirement.

Regular checkups with your financial consultant—like regular medical checkups—can uncover problems before they start. This will ensure you’re on track to meet your financial goals.

For more information about retirement planning or other financial planning topics, contact an MD Advisor. MD offers objective advice at every stage of your career—from medical school through retirement. Find an MD Advisor near you.


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