Author Topic: Real return rate  (Read 6906 times)

dbooksta

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Real return rate
« on: October 09, 2013, 08:05:35 AM »
What is the real return rate assumed by MMM?  I'm just starting to read some of the articles but it seems significantly -- even absurdly -- large.

Market estimates of real returns on liquid assets for the foreseeable future -- i.e., at least the next decade -- are minimal.  Like a point or two above inflation.

I know pessimism isn't a big part of the MMM philosophy, but I can't see any securities with risk-adjusted returns that would keep a portfolio significantly above inflation.  Obviously plenty of people here disagree, so I'd love to hear what you think a plausible future real return rate is and how one might obtain it.  NB: For market securities you can't blindly reference historical rates.  It's much more sound to look at the current futures and rate markets.

sherr

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Re: Real return rate
« Reply #1 on: October 09, 2013, 08:21:21 AM »
He generally assumes the historic averages of 7% returns less 3% inflation.

KingCoin

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Re: Real return rate
« Reply #2 on: October 09, 2013, 08:58:51 AM »
There are tons of real estate investments that should return inflation +4%. If you're willing to buy individual properties (less liquid) you shouldn't have too much trouble generating inflation +7% (even after farming out the management).

Do you have any reason to believe stocks won't generate inflation +4-5%? They don't look screamingly cheap at the moment, but they're not trading much outside historical norms.

Bonds? Yeah, you're pretty much shooting for inflation -2% to inflation +2% depending on where you land on the risk spectrum. Not much you can do here unless you want to roll up your sleeves and find individual opportunities that look extra attractive.

RobertBirnie

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Re: Real return rate
« Reply #3 on: October 09, 2013, 10:33:58 AM »
He generally assumes the historic averages of 7% returns less 3% inflation.

I've seen MMM refer to this numerous times, 7% return less 3% inflation. I was always under the impression though that real rate of return historically has been 6.5 to 7% counting inflation, so combined it's really about 10%. Then the 4% withdrawal rule comes from 4% withdrawal, 3% inflation, and then 3% so that your nestegg grows faster than inflation, ensuring larger payments over the life of the withdrawals.

Quote
Siegel argues that stocks have returned an average of 6.5 percent to 7 percent per year after inflation over the last 200 years
http://en.wikipedia.org/wiki/Stocks_for_the_Long_Run

kyleaaa

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Re: Real return rate
« Reply #4 on: October 09, 2013, 03:21:36 PM »
Personally, I assume 3% real. Hopefully I'm being overly conservative, but I don't think it's smart to count on much more than that.

Dezrah

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Re: Real return rate
« Reply #5 on: October 10, 2013, 09:51:20 AM »
Quote
Then the 4% withdrawal rule comes from 4% withdrawal, 3% inflation, and then 3% so that your nestegg grows faster than inflation, ensuring larger payments over the life of the withdrawals.

This is not correct.  The study the SWR was based on was framed in this manner:

Withdraw x% of funds every year for a standard retirement life (about 25 years).  Then let the funds follow the path of the general market starting in 1927 for that 25-year time frame.  How high can x be such that funds do not run out within 25 years but get very close to zero.  Document x-1927.  Repeat starting with year 1928 instead and document x-1928.  Do this until you have exhausted all applicable years (present minus 25).  Plot all x's.

It turned out that 4% was the lowest SWR of all time frames.  In most cases, the SWR is actually a lot higher.  The reason it is recommend that one only withdraw that 4% is based the fact that you don't know if you're starting at a peak (market will drop) or valley (market will climb) in the market, so you should plan for the peak.

The fact that 4%(withdraw)+3%(inflation)=7%(market growth) is coincidental.

Personally, though I am not yet FIRE, I would use the 4% rule to judge whether my situation is sustainable.  If the market were to drop substantially and last year's expenses are now more than 4% of these funds, it's time to re-evaluate getting a job and/or lowering expenses.

The Financial Lexicon

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Re: Real return rate
« Reply #6 on: October 10, 2013, 10:23:32 AM »
Don't forget to factor in the extent to which dividends helped to drive historical returns in equities.  Then look at today's dividends yields and adjust your expectations accordingly. 

The Financial Lexicon

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Re: Real return rate
« Reply #7 on: October 10, 2013, 10:38:20 AM »
@KingCoin,

I can generally agree with this statement: "They don't look screamingly cheap at the moment, but they're not trading much outside historical norms."  But investors also need to recognize the change in the mix of what is driving earnings growth (it's not revenue growth to the extent it historically was) and the fact that easy monetary policy has helped to prop up the multiple assigned to the pathetically slow earnings growth of the past couple of years. 

Over the past two years, S&P 500 earnings have grown a total of just 7.90% (remember that's two years of total earnings growth, not one).  If investors were offered the opportunity to purchase a stock growing earnings in the low-to-mid single digits and trading at a P/E in the mid-teens, a lot of people would say no.  But when the broader market does that, people say yes.  And the reason they say yes all has to do with extremely rosy forward estimates making stocks continually look cheap.  Of course, stocks are only cheap in the present based on forward estimates if those forward estimates can be realized.  Forward analyst estimates for the S&P 500, however, have consistently been wrong for two straight years.  Yet people continue to cite forward estimates as the reason that stocks don't appear expensive.  And the reason people are willing to ignore what I think historically would not have been ignored all has to do with the Fed effectively forcing people who are searching for income into riskier assets.  If you don't think the Fed's easy money policy will last forever . . . well, just work backwards through this post and the future effects of Fed tightening will become clear.

Just something to keep in mind.

 

Undecided

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Re: Real return rate
« Reply #8 on: October 10, 2013, 11:40:54 AM »
Don't forget to factor in the extent to which dividends helped to drive historical returns in equities.  Then look at today's dividends yields and adjust your expectations accordingly.

For an individual issuer, dividend yields may be a worthwhile consideration (a dividend payer can afford to pay dividends ...), but for a broad index, I'm not convinced that changes in dividend rates tell us a lot. But I'd love to know otherwise---do you know of any literature on the (tax-segregated) relationship between changes in market-wide dividend rates and overall equity returns?

aj_yooper

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Re: Real return rate
« Reply #9 on: October 10, 2013, 12:49:33 PM »
What is the real return rate assumed by MMM?  I'm just starting to read some of the articles but it seems significantly -- even absurdly -- large.

Market estimates of real returns on liquid assets for the foreseeable future -- i.e., at least the next decade -- are minimal.  Like a point or two above inflation.

I know pessimism isn't a big part of the MMM philosophy, but I can't see any securities with risk-adjusted returns that would keep a portfolio significantly above inflation.  Obviously plenty of people here disagree, so I'd love to hear what you think a plausible future real return rate is and how one might obtain it.  NB: For market securities you can't blindly reference historical rates.  It's much more sound to look at the current futures and rate markets.

There is more variability than 1-2 % real, but it varies by risk levels.  Here is Rick Ferri's 2013 forecast, which is also considerably lower than MMM's:  http://www.portfoliosolutions.com/2013marketforecast/

Interestingly, MMM retired, basing his stash on a 4% SWR, but he funds his retirement from real estate and a paid for home.  His stash is untouched and growing % by his side jobs and market appreciation.