A good retirement income plan is based on assumptions about future economic outcomes, such as stock market performance, interest and dividend yields, and inflation. In case you were wondering, sometimes assumptions go off the rails. Just to confirm my theory, I went back to December 2021 to see the predictions for 2022.
Prediction: The Dow Jones will hit 38,000 for the first time.
What happened: The Dow hit its market closing high of 36,799 on January 4, dipped to 28,725 on September 30, and has been bouncing between 32,000 and 35,000 of late.
Prediction: The market will control inflation, with a “manageable increase” of 2% to 3%.
What happened: Inflation it is now considered “under control”, at 7.1% for the year ending November 2022.
Prediction: The Fed will not raise rates significantly.
What happened: In December, the interest rates raised by the Fed for the seventh time this year.
Jeff Sommer, financial columnist for The New York Timesmade a similar comment about market forecasts (opens in a new tab): “Undoubtedly, in 2023 enormous changes are coming that are not yet visible. Inflation and interest rates worry financial markets now, but there is no certainty that this will be the case in a year’s time.
I agree with him. That’s why Go2Income doesn’t predict but prepares you for the future.
In this article, I’ll focus on how to get comfortable with the assumptions behind your plan. We’ll be looking at the changes to the Go2Income planning model just made on December 1st. Importantly, you will also see how to stay the course even after a year like 2022.
What you need to understand about assumptions
Even if you studied English instead of economics, you can still learn how to plan for your financial future. When designing a plan for your retirement future, you need to understand the following:
- What market assumptions are used in your retirement income planning model, and how do they affect your plan in terms of income, liquidity, and legacy?
- How volatility in the market impacts your plan, and plan adjustments can do in response. (And specifically, how much of your income is subject to market volatility.)
- The ways in which a plan based primarily on withdrawals and the resulting sale of securities could also make you below market performance — for not being in the market at the right times.
Let’s see how assumptions can affect your income.
Selecting Assumptions Regarding Stock Market Returns
For our typical investor who invested in a Go2Income plan that represents a combination of Social Security, annuity payments, interest and dividends, and IRA withdrawals, only 20-25% of their planned income is subject to market volatility. The charts below show a projection of your plan’s income assuming a long-term stock market return of 8% vs. a 4% stock market return.
Assumptions are critical in your planning. As you can see, a 4% yield provides lower income for 25 years. But you can also say it’s not catastrophic, because much of our Go2Income investor income is “safe,” coming mostly from sources other than IRA withdrawals.
What stock returns should you assume when designing your plan?
Most investors are aware of the risks of investing in the stock market and the rewards. In addition to actual market returns, there is also the risk that you will abandon a well-constructed plan just because the latest market results look bad. Let’s take a look at how the stock market has performed over 10, 20, and 30-year periods as measured by the S&P 500 Index.
In the Go2Income planning model, our default assumption is 8% (after asset management fees and before advisor fees). An adviser can assume between 3% and 9% in your planning. Of course, the only type of portfolio used in planning the riskiest IRA withdrawals is a balanced portfolio of stocks and fixed income.
How to Select Market Assumptions Regarding Fixed Income Portfolio and Dividend Yields
In a Go2Income model, we review fixed income market assumptions at least quarterly; annuity rates are reviewed monthly. We make the assumptions related to fixed income and dividend yields; others, such as the stock market outlook and inflation rate, may be set by your adviser after consultation with you. In addition, the assumptions selected or recommended by an adviser will be influenced by plan design, particularly the allocation to stocks and annuities.
After reviewing the data and consulting with FolioBeyond (opens in a new tab)We made the following changes to the Go2Income model starting December 1.
- Dividend yield: It increased from 3.25% to 3.5%.
- Interest Yield: It increased from 2.5% to 3.5%.
- Fixed Income Total Return: It increased from 3.5% to 4.5%.
While not an assumption per se, we determined that, on average, annuity payment contracts were credited with a lifetime interest rate of 5.25% as of December 1. Some were taller; others were shorter. Of course, you will be able to select the company with the best rates when you implement a plan. To get a quote based on current rates, fill out the widget at our welcome page (opens in a new tab).
And the inflation?
With the investment assumptions in place, we need to select assumptions about long-term inflation.
These are the results of the last 30 years of the Consumer Price Index (CPI), (opens in a new tab) considering all periods of 10 and 20 years using the compound rate of inflation during the period.
Despite 2022, the long-term median inflation rate is still around 2.75%. Our default assumption for the future remains 2%, but with your revenue target adjusted for recent inflation. Of course, you and your adviser can select your own inflation assumption, recognizing that your Social Security benefits will follow inflation. Inflation is another example of adjusting your current income target in real time, while making sure your long-term assumptions are neither too aggressive nor too conservative.
Finally, what did the updated assumptions do to my plan income?
With the plan assumptions in place and no change to the source of income allowance, we can create your December 2022 plan and compare it to one from a year ago. So the new plan is generating plan income that is almost 19% higher, and if your market losses were 20% or less, you’re complete.
But do you implement it now?
The goal of this year-end article is to help you think about your retirement income plan, with updates that reflect current market assumptions. But do you implement it now? Do you implement in part with, say, the IRA rollover portion only? Do you buy annuities in one or both accounts? Or maybe investment portfolios?
One thing you should definitely put on your to-do list: re-evaluate your plan at the end of 2023.
My January 2023 article will offer information to help you act on your assumptions and execute a personalized plan to best benefit you and your family.
Get the numbers for your own retirement. To visit Go2Ingress (opens in a new tab), answer a few simple questions, and get started on your own retirement plan. This service is a complement to our other services, and you can request a Go2Specialist to help answer your planning questions. We also have advisors available who can help you with the next steps to refine and then implement your plan.