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© 2010 Morningstar. All Rights Reserved. 3/1/2010
Retirement Income
Then and NowAsset allocation before and after retirement
© 2010 Morningstar. All Rights Reserved. 3/1/2010
Before retirement Accumulation Long-term growth Current savings Time to recover Tax-deferred growth
After retirement Disbursement Long-term growth Current income Downturns immediately felt Minimum required distributions Taxes
Retirees Face Numerous Risks
© 2010 Morningstar. All Rights Reserved. 3/1/2010
Withdrawals What rate is sustainable? Sequencing by tax bracket Managing RMDs
Retirementincome
Retiree spending Replacement ratio Essential versus lifestyle
expenses Medical expenses
Market volatility Uncertain returns and
income Impact of point in time Asset allocation and location
Longevity Long retirement horizons—
a couple aged 65 has 25%chance of a survivor livingto age 96
Solvency Pension plans and retiree
benefits—a thing of the past Social Security and Medicare
Savings Under-funded defined
contribution accounts Most Americans have an
enormous savings gap
Inflation Erodes the value of savings
and reduces returns Health care inflation 5%
Retirees Should Plan for a Long RetirementProbability of a 65-year-old living to various ages
Source: Annuity 2000 Mortality Tables. © 2010 Morningstar. All Rights Reserved. 3/1/2010
0
25
50
75
100%
65 years old 70 75 80 85 90 95 100 105
• Male
• Female
• At least one spouse
78 86
85 91
91 96
81
88
93
Retirees Need to Replace a Significant Amount of Income in RetirementAverage replacement ratios at various pre-retirement income levels
Data is from Aon Consulting’s 2008 Replacement Ratio Study: A Measurement Tool for Retirement Planning. © 2010 Morningstar. All Rights Reserved. 3/1/2010
94%
90%
85%
81%
78%77% 77%
78%
84%
86%
88%
65
70
75
80
85
90
95% Replacement ratio
$20k 30 40 50 60 70 80 90 150 200 250
Pre-retirement income
Personal Savings Expected to Play a Larger Role in RetirementSurvey of retirement income sources
Source: Employee Benefit Research Institute, 2009 Retirement Confidence Survey. © 2010 Morningstar. All Rights Reserved. 3/1/2010
0
20
60
100%
40
80 81%
92%
75%
40%
70%
47%
63%
41%
59% 58%
Social Security Employer-sponsored retirement savings
plan (ex. 401k)
Other personalsavings/investments
Individual RetirementAccount (IRA)
Employer-providedtraditional pension plan
• Workers (Expected)
• Retirees (Reported)
Social Security is Under StrainNumber of beneficiaries per 100 covered workers
Low-cost—assumes relatively rapid economic growth, low inflation, and favorable (from the standpoint of program financing) demographic and program-specific conditions; Intermediate—represents the Trustees’ best estimates of likely future demographic, economic, and program-specific conditions; High-cost—assumes relatively slow economic growth, high inflation, and unfavorable demographic and program-specific conditions. © 2010 Morningstar. All Rights Reserved. 3/1/2010
20501960 1970 1980 1990 2000 2010 2020 2030 2040
Historical Estimated
60
40
30
20
0
10
50
• Low cost• Intermediate• High cost
Inflation Significantly Erodes Purchasing Power Over TimeEffects of 3% inflation on purchasing power
Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. © 2010 Morningstar. All Rights Reserved. 3/1/2010
$100k
80
60
40
20
0
0 Years 5 10 15 20 25 30
$73,742
$63,325
$54,379
$46,697
$40,101
$85,873
Inflation and Taxes Reduce ReturnsCompound annual returns,1926–2009
Past performance is no guarantee of future results. Assumes reinvestment of income and no transaction costs. Inflation rate over the time period 1926–2009 was 3.0%. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2010 Morningstar. All Rights Reserved. 3/1/2010
CashBondsStocks
–2
0
2
4
6
8
10%
Return Afterinflation
After taxes& inflation
Return Afterinflation
After taxes& inflation
Return Afterinflation
After taxes& inflation
9.8%
6.6%
4.6%
5.4%
2.3%
0.3%
3.7%
0.6%
–0.7%
Sustainable Withdrawal Rates Vary Over TimeRolling 30-year periods 1926–2009
Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2010 Morningstar. All Rights Reserved. 3/1/2010
2
4
6
8
10
12%
Jan 1926Dec 1955
19762005
19311960
19361965
19411970
19461975
19511980
19561985
19611990
19661995
19712000
• 75% stocks/25% bonds• 50% stocks/50% bonds• 25% stocks/75% bonds
Withdrawal Rate You Can Sustain May Be Lower Than You ThinkAverage: 1926–2009
Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2010 Morningstar. All Rights Reserved. 3/1/2010
6.05%
5.20%
4.33%
0
1
2
3
4
5
6%
75% Stocks/25% Bonds 50% Stocks/50% Bonds 25% Stocks/75% Bonds
The Sequence of Returns Can Significantly Affect Your RetirementSequence of returns matters
Past performance is no guarantee of future results. Hypothetical value of $500,000 invested at the beginning of 1973 and August 1994. Assumes inflation-adjusted withdrawal rate of 5%. Portfolio: 50% large-company stocks/50% intermediate-term bonds. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2010 Morningstar. All Rights Reserved. 3/1/2010
$500k
400
300
200
100
0 1973 1977 1981 1985 1989 1993 1993 1989Aug 94
1985 1981 1977 1973
0.5
1.0
1.5
2.0
$2.5 mil
Actual historical return sequence Reversed historical return sequence
Discussion of Simulation Criteria and Methodology
© 2010 Morningstar. All Rights Reserved. 3/1/2010
Many of the following images were created using Monte Carlo parametric simulation. This model estimates the range of possible outcomes based on a set of assumptions including arithmetic mean (return), standard deviation (risk), and correlation for a set of asset classes. The inputs used herein are the historical 1926–2009 figures. The risk and return of each asset class, cross-correlation, and annual average inflation over this time period follow. Stocks: risk 20.5%, return 11.8%; Bonds: risk 5.7%, return 5.5%; Correlation –0.01; Inflation: return 3.1%.
Note that other investments not considered may have characteristics similar or superior to those being analyzed. Each simulation produces 35 randomly selected return estimates consistent with the characteristics of the portfolio to estimate the return distribution over a 35-year period. Each simulation is run 5,000 times, to give 5,000 possible 35-year scenarios. A limitation of the simulation model is that it assumes the distribution of returns is normal. Should actual returns not follow this pattern, results may vary.
Interpreting Confidence Levels in Simulation
This table is intended to help interpret 50%, 75%, and 90% confidence levels illustrated in the following images. © 2010 Morningstar. All Rights Reserved. 3/1/2010
50%
75%
90%(More conservative)
50%
75%
90%
25%
10%
50%
Confidence level Chance of exceeding Chance of falling short
Simulation Can Illustrate the Probability of Achieving OutcomesA visual interpretation of confidence levels in simulation
IMPORTANT: Projections generated by Morningstar regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary over time and with each simulation. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2010 Morningstar. 3/1/2010
$10 mil
1 mil
100k
10k
65 Years old 70 75 80 85 90 95 100
• 50% confidence level• 75% confidence level• 90% confidence level
High Withdrawal Rates Will Quickly Deplete Your AssetsSimulated portfolio values (90% confidence level)
IMPORTANT: Projections generated by Morningstar regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary over time and with each simulation. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2010 Morningstar. 3/1/2010
Withdrawal rate: 8% 7% 6% 5% 4%
$1 mil
500k
100
50
10
65 years old 100959085807570
Market Performance Affects Chance of Portfolio ShortfallSix percent inflation-adjusted withdrawal at three confidence levels
IMPORTANT: Projections generated by Morningstar regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary over time and with each simulation. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2010 Morningstar. 3/1/2010
$1 mil
500k
100
50
10
65 years old 100959085807570
• 50% confidence level• 75% confidence level• 90% confidence level
High Withdrawal Rates Will Quickly Deplete Your AssetsAge to which a portfolio may last based on withdrawal rate (90% confidence level)
IMPORTANT: Projections generated by Morningstar regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary over time and with each simulation. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2010 Morningstar. 3/1/2010
74
75
77
79
82
86
94
100+
• Portfolio:Stocks 50%Bonds 40Cash 10
10%Withdr.rate
9
8
7
6
5
4
3
Age 65 70 75 80 85 90 95 100
Probability of Meeting Income NeedsVarious withdrawal rates and portfolio allocations over a 25-year retirement
IMPORTANT: Projections generated by Morningstar regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary over time and with each simulation. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2010 Morningstar. All Rights Reserved. 3/1/2010
85%
34%
4%
0%
0%
97%
72%
28%
5%
0%
96%
81%
54%
28%
12%
93%
80%
62%
44%
28%
90%
78%
64%
50%
38%
4% Withdrawal rate
5%
6%
7%
8%
100%Bonds
75% B25% S
50% B50% S
25% B75% S
100%Stocks
Providing for Retirement Income
© 2010 Morningstar. All Rights Reserved. 3/1/2010
Retirement risks can be managed by intelligent combination of funds, stocks and bonds, and insurance products
How do you find the right asset mix for retirement? age and risk tolerance desire for consumption and bequest expenses and fees of product choices