December 11, 2013 – Low investment returns loom in the decades ahead, spelling bad news for retirement savers and pension plan managers, according to a report released today by the C.D. Howe Institute. In “Long-Term Returns: a Reality Check for Pension Funds and Retirement Savers,” authors Richard Guay and Laurence Allaire challenge widely used “optimistic” assumptions for investment returns based on historic experience, with more realistic ones using current Canadian data .
“Some pensions could face bigger pension liabilities and individual savers will have to save more or work longer, if they are to avoid a large drop in their post-retirement lifestyles,” commented Richard Guay.
In the report, Guay and Allaire demonstrate why pension plan administrators and individual savers should avoid using historical rates of returns to forecast future returns. They provide their own forecast for long-term investment returns on a balanced portfolio of bonds and stocks using current and prospective market information.
Guay and Allaire predict long-term returns in the neighbourhood of 2.5 percent (0.5 percent real) on long-term bonds and of 6.9 percent (4.8 percent real) on stocks. For a balanced portfolio (50/50 split), they therefore expect a real return of 2.7 percent for the next decade. By contrast, the average expectation for real returns among Canadian pension funds is 4.3 percent, they note.
The authors draw implications for pension funds and individual savers. “Defined-benefit pension plans should acknowledge these realities,” said Laurence Allaire, “Adjustment might be required, which will be difficult, to reduce costs and deficits to acceptable levels.”
The authors also show how lower returns will affect individual savers who have different incomes and income-replacement targets. For example, for a saver to reach the popular target of 70 percent income replacement for a $50,000 final income, the necessary savings rate, over 30 years, jumps from less than 10 percent of gross annual salary to 14 percent of salary. Or, savers can work longer.
“More realistic return assumptions mean individuals should save more for their retirement or postpone retirement for two years to enjoy their desired lifestyles, said Guay.
Click here for the full report.
For more information contact: Richard Guay, Professor of Finance, UQAM and Fellow, CIRANO; Laurence Allaire Jean, former Project Director, CIRANO Finance Group; Alexandre Laurin, Associate Director of Research, C.D. Howe Institute, 416-865-1904; email: cdhowe@cdhowe.org.