The frame of reference through which we view our world and make decisions is the result of our experiences and perceptions. That frame, more times than not, is static. It represents a certain outlook or position. While frames of reference are essential to making decisions, they tend to have a major flaw in that there is often a disconnect with a dynamically changing world.
We see this paradox in many aspects of our client’s lives, in addition to the economy at large. It seems that frames change reluctantly and often after they have outlived their usefulness. For example, there has been much discussion of late about the lack of growth in our economy. The nonpartisan Congressional Budget Office has released a report that projects GDP, our nation’s total of goods and services to be at an anemic 2.1% for the next decade.
If their projections are accurate, they portend significant changes for future rates of return. After coming off a year of 30% stock market returns, it may seem far fetched to broach the subject of lower than historical returns for stocks, as well as bonds or cash investments. We all have our frames of reference, and most everyone would prefer double digit stock returns to numbers in the mid-single digits.
Aside from this rather obvious fact, the funding mechanisms for pensions, governments, and corporations could change significantly over the next decade. Pension funds are what we call defined benefit plans. Their job is to match up long term liabilities (your pension) with current contributions that fund those liabilities. The most significant factor determining these annual contributions to the plans is the implied rate of return on their investments. A lower rate environment will force employers to contribute much more to their plans.
For corporations this means lower profits. For municipalities it means either higher taxes or fewer services. Publically traded corporations as well as municipalities have a vested interest in static framing. It makes them look good. One other factor should contribute to lower future returns: the historically low level of interest rates in the United States. Much of the return on bonds over the past three decades has come from a decline in interest rates; thereby creating capital gains. Those gains will not be revisited, as rates have really only one way to go from here – up.
Static framing enters into retirement planning at many levels. For instance, many people welcome longer life expectancies, but are unrealistic about how long they expect to survive on their assets. For most people it will be exceedingly tough to survive for 30 years on their retirement savings. The idea of increased longevity requiring a longer career is a foreign concept to many. It is great to have more leisure time, not so great though if you are broke.
Most retirement planning assumes that account draws will increase with inflation. Taking this static approach to producing a retirement income stream over a period of decades can inadvertently cause someone to have an unnecessarily diminished lifestyle prior to retirement, and an overfunded account balance during their retirement years.
Author Michael Stein has popularized a three factor model of retirement that moves from the “go-go” years to the “slow-go” years and into the “no-go” years. His model is designed to play out over 35 years from ages 60 through 95. The basic tenant of his model is that people will tend to spend more money during the years that they are most active. As their health or mobility decreases, typically so does their spending. Spending will tend to flat line when they are living in an assisted living or skilled care facility.
Most of us find comfort in a routine. It is important that we not get too comfortable in our thinking about the future. This is especially critical today as the world changes at such a rapid pace. Technological developments are making increasing numbers of jobs irrelevant. In such an environment we must all embrace lifelong learning. It can be wonderful to live in an age of technological wonders, but you have to put the time in to learn how the technology can make your life easier or more enjoyable.
This is indeed a great time to be alive, so long as you do not view it through the rear view mirror of static framing.