Kitces blog (Long Term Savings, Relying On Returns, And Retirement Date Risk – Kitces | Nerd’s Eye View) makes the excellent point that the traditional method of investment planning (save an amount and rely on compounding to work its magic) has some, heretofore unrecognized risks. Mainly it relies on the compounding magic to work in the last few years, precisely when those returns may not materialize.
Result? The accumulated sum of money doesn’t materialize when it should for retirement as planned.
Solution? Counter intuitively, save a little more than you would have counting on higher returns, and dial back the exposure to value fluctuations by reducing the allocation to equity. Saving more has the obvious effect of having a higher relative balance. Reducing the equity exposure is counter intuitive because the expected return is less than it would be with a higher stock exposure. However, precisely because of that higher stock exposure is where the risk of not getting those needed returns at the end of the saving period comes from.
Moral of the story: relying on returns is risky because, as the 2000’s showed, returns aren’t really under your control. A balance between spending and saving so you reach your retirement target … so you can sustain your standard of living into and through retirement is your real goal.
For those who want to dig deeper for greater understanding:
Here is a blog I had posted related to this topic based on work done by Dr Craig Israelsen.
Here’s a separate link to Dr Israelsen’s article, to answer those who may think about the allocation question during the savings years, and if it is important or not, what order the returns are during the savings years.
PS. Happy New Year … and may this provide you more support to those who resolve to do more towards retirement.