Retirement plan accuracy: overstated rates of return and false hopes

How much do you need to retire?

If you are like most Canadians, maintaining your standard of living in retirement ranks at or close to the top of your financial goals. Financial advisers typically use software to estimate retirement income for clients.

These programs usually use stock and bond market index returns to calculate and estimate long-term rates of return for your investment portfolio.

Indexes, such as the TSX/S&P60 in Canada and the S&P500 Index in the U.S., track the performance of a large basket of stocks or bonds; in some cases they may track up to several thousand.

Market indexes also function as benchmarks against which investors can evaluate the performance of their own portfolios, and in recent years, investment vehicles through companies like Dimensional Fund Advisors and Barclays Global Investors Ltd.

The problem with using index returns to estimate portfolio growth is that most investors will underperform the indexes. The implication is that most retirement income projections overstate asset levels, and thus will overstate your retirement income.

Traditionally managed investment portfolios such as stock brokerage accounts, actively managed mutual funds, and traditional discretionary portfolios have underperformed stock and bond market indexes consistently.
Much research has been done comparing how active money managers fare against a simple buy and a hold index investment strategy. The results are not good for active managers.

The most recent study by Russ Wermers of the University of Maryland, entitled “False discoveries in mutual fund performance: Measuring luck in estimating alphas,” suggests long-term outperformance is due to luck, rather than the skill of the money manager.

The fact is financial markets in the developed world are efficient; they do a very good job of estimating fair prices based on available data. Unless one can predict the future, choosing investments that will outperform relative to the market becomes folly.

According to the most recent “Standard and Poor’s Indices Versus Active” (SPIVA) report, roughly 90 per cent of traditional money managers underperformed domestic and international stock and bond market indexes over the past 10 years.

Ask your financial adviser if index rates of return are used in running your retirement projections.

If you are using index returns to calculate your projected portfolio growth, consider having them recalculate your retirement income projection using a lower rate of return.

Burton Malkiel of Princeton University studied U.S. mutual fund returns from 1970 to 2006 and found the majority of funds underperformed the S&P500 by two per cent or better. 

So, if you invest in actively managed investments such as mutual funds, consider reducing the rate of return assumption in your retirement projection by two per cent so as not to overstate your expected retirement income.


Alan Acton CFP, CIM, FCSI is a financial adviser in Ottawa and can be reached at The opinions expressed are those of Alan Acton and not necessarily those of Raymond James Ltd. Statistics, data, and other information are from sources believed to be reliable but their accuracy cannot be guaranteed.

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