Equity risk premium … what economists call expected stock returns. The first part of the video is the academic perspective of expected equity returns. Of interest, and the purpose of my blog, is the later half of the short video (2:39) … “Why should anyone care?”
Why does this matter? Because … Pensions are likely underfunded when returns are lower than expected for their calculations. If returns are lower than expected, then funding for pensions from those now-lower returns is not possible. Individuals are also underfunding their plans based on expectations of returns from their past experiences. Today’s markets are not like the past. This is why I rarely use market returns in retirement planning; rather, stochastic modeling, or probability simulations provide a range of possible future returns.
Moral of the story: You need to save more. And this comes as no surprise since Americans tend not to save enough to begin with when it comes to their retirement funds.
In truth, the amount of your contributions (or distributions in retirement) are more important than returns. If you think about it, if there are no contributions, then no matter how high the return, there’s still nothing there. To see how this looks visually, see my contributions blog.
Source: The Economist.