If you grew up in the Christian church, as many Americans have, you probably vaguely remember the story of the Four Horsemen. These Horsemen are referenced in the Book of Revelations, the last book of the New Testament of the Bible. Theologians differ on what these Horsemen represent. But contemporary culture often refers to them as Pestilence, War, Famine and Death. Notably these figures show up in the apocalyptic Christian vision of the Last Judgment.
But, we are not here to discuss theology. We were reminded of the Four Horsemen by Larry Swedroe in his book, Your Complete Guide to a Successful and Secure Retirement. Swedroe describes The Four Horsemen of the retirement apocalypse as “historically high equity valuations, historically low bond yields, increasing longevity and the resulting need for what can be very expensive long-term care.” (see page 3).
We have written about all of these challenges in the past. But let’s consider what Swedroe has to say about them.
Historically Hight Equity Valuations
Swedroe points out that between 1926 and 2017 the S&P 500 index – a proxy for large company US stocks – produced an average annual return of just over 10%. Many investors today also expect a 10% return from US stocks.
Swedroe points out that this is not likely, because the equity risk premium (i.e. the extra return investors can expect for investing in stocks, above that of safe government bonds) has been falling. He proposes the Shiller CAPE ratio as the best estimate of future returns. The CAPE ratio is used to assess whether the stock market is overvalued or undervalued. It compares stock prices to earnings, adjusted for inflation, over a 10-year time period.
When Swedroe wrote his book at the beginning of 2018, the CAPE ratio stood at 32. He suggested that the best indicator of future stock returns is the inverse of the CAPE ratio, or the earnings yield (earnings divided by price). The result is a forecasted real return of 3.1%. He then adjusts this figure for inflation to produce a nominal return and ends up with a projected return for US stocks of 5.1%. This is half of what investors have seen historically.
Historically Low Bond Yields
During the same period, 1926 to 2017, Swedroe notes that the 5-year US Treasury bond returned 5.1%. He then points out that at the end of 2017, the yield on the 5-year Treasury was 2.3%. Today the same bond is yielding roughly the same.
So, projected returns for both stocks and bonds are roughly half of that they were historically. Using a 50% stock and 50% bond portfolio as an example, we get a projected return of 3.7% (50% of 5.1%, plus 50% of 2.3%).
Increasing Longevity
Thanks largely to improvements in medicine, people are living longer. In 1900, life expectancy in the US was 47. Swedroe points out that today “a healthy male (female) at age 65 has a 50% chance of living beyond the age of 85 (88) and a 25% change of living beyond the age of 92 (94).” He advises those intending to retire in their mid 60s to have at least a 30-year planning horizon.
The Risk of Needing Care
Swedroe does not provide a lot of data on the likelihood of a retiree needing care later in life to help with so-called “activities of daily living”. He does note that the incidence of Alzheimer’s disease “doubles about every five years after (age) 65.” After age 85, one in three people are diagnosed with the disease. Needless to say, the cost of caring for someone who has physical and/or cognitive impairment is significant. We have shared these statistics in the past and they are readily available online.
While these Four Horsemen present serious challenges to anyone planning for retirement, they should not be insurmountable. At Springwater, we “stress test” every client’s retirement plan for lower investment returns, longevity, and for one day needing care, at home or in a facility. Through careful planning, you can prepare for these Horseman and avoid the calamity they can present to the unprepared.
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