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Your Retirement Savings Might Not Go as Far

With bond yields low and stock valuations high, future returns may be smaller than you think.

How low can you go?

That’s the question for investors as the era of near-zero short-term interest rates stretches into its eighth year, throwing into doubt long-held assumptions about the returns they can expect from their savings. In the U.S., 10-year Treasuries—a mainstay for those looking for a safe yield—pay just 1.75 percent a year. Elsewhere in the developed world, about $7.9 trillion in government bonds will effectively pay a negative yield if they’re held to maturity.

Stocks are much less predictable, but there’s reason to lower expectation for equity returns as well. Perhaps in part because the returns available from bonds are so low, investors have pushed up the valuations of equities in the years since the crash in 2008. Here’s one simple measure: Stocks on the S&P 500 trade at an average price of 19 times earnings, up from about 10 times in early 2009 when the current bull market began.

“Right now, things look pretty bleak for the next 10 years,” says David Blanchett, who’s head of retirement research at Morningstar. This may come as an especially rude shock to investors in the U.S., where stocks have earned an annualized average of about 10 percent over the long term. “The U.S. has had a higher return for a balanced portfolio for the last 115 years than almost any other country in the world,” he says. “We’ve had it really good for a long time.”

Assuming a lower baseline for investment returns has consequences for a range of financial planning decisions, including how much to save, how much to withdraw in retirement, and where to invest.

Bill McNabb, chief executive officer at mutual fund giant Vanguard, says bonds—including higher-yielding corporate debt—are likely to average 2 percent to 3 percent over the coming decade. A combined global and U.S. stock portfolio might earn about 7 percent. “Over the next 10 years, the markets aren’t going to bail you out if you haven’t saved enough,” he says.

If so, lower returns will have the most immediate impact on people who are in or near retirement. Financial planners often cite an old rule of thumb that retirees can set annual spending at 4 percent of the value of their nest egg, then raise the dollar amount each year with inflation. Today, a 3.5 percent initial withdrawal might be more realistic, says planner Harold Evensky of Evensky & Katz/Foldes Financial. For a retiree with $2 million, switching from 4 percent to 3.5 percent means a $10,000 reduction in yearly income. Evensky says some retirees will likely instead respond by allocating more of their portfolios to stocks to reach for higher returns.

At the other end of the spectrum, for people turning 30, deflated returns will mean they’ll have to work seven years longer or save almost twice as much to end up with the same nest egg as those born roughly a generation ago, according to an April report by McKinsey. The prior generation enjoyed what the consulting firm calls a golden era of high returns based on declining inflation and interest rates, swelling corporate profits, and an expanding price-earnings ratio for stocks. Now inflation and rates can hardly get lower, and the other factors seem unlikely to recur.

Blanchett says some of the best strategies to boost returns from here on might be behavioral. Make the most of tax-advantaged savings programs such as 401(k)s and individual retirement accounts and pay close attention to the fees you pay on investments. Minimizing debt could help, too. What you save on interest by paying off a loan may beat the returns you’ll get from stocks and bonds, says Blanchett.

Not everyone in the market is ready to accept the idea of low returns. “The fact that people are unrealistic is actually creating risky behavior in the way that they are putting money to work,” said David Hunt, head of Prudential Financial’s asset management unit, in a Bloomberg Television interview in May. That risky behavior may create streaks of high returns as investors keep plowing money into hot corners of the market—but whenever that happens, bubbles tend to inflate and burst.

Economist and former Treasury Secretary Lawrence Summers has argued that the world may be in a prolonged period of “secular stagnation,” characterized by slow growth, low interest rates, and periodic asset bubbles and crashes. Even if that’s too sweeping a claim, it seems that the Federal Reserve and its counterparts around the world don’t expect a quick return to normal.

“There clearly isn’t any great appetite among the central banking community to raise rates materially,” says Adrian Grey, head of active management at London-based Insight Investment. “People need to get their heads around that this could be here for a while.”

The bottom line: Today’s skimpy bond yields suggest that it makes sense to prepare for lower long-term returns on savings.

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