If Vanguard Is Right, You’ll Need to Save More For Retirement

By Pam Martens and Russ Martens: November 28, 2017

Broken Piggy BankVanguard is one of the largest mutual fund companies in the world with 20 million investors and approximately $4.5 trillion in global assets under management as of September 30, 2017, according to its website. When it expounds on the outlook for the stock market, people tend to listen closely.

Yesterday, Vanguard issued its economic and stock market outlook for the medium term, writing: “For 2018 and beyond, our investment outlook is modest, at best. Elevated valuations, low volatility, and secularly low interest rates are unlikely to be allies for robust financial market returns over the next five years.”

Exactly how “modest” does it expect stock market returns to be over the medium term? The report goes on to define “modest” as follows:

“Based on our ‘fair-value’ stock valuation metrics, the medium-run outlook for global equities has deteriorated a bit and is now centered in the 4% – 6% range. Expected returns for the U.S. stock market are lower than those for non-U.S. markets, underscoring the benefits of global equity strategies in the face of lower expected returns.”

If your retirement savings strategy has factored in an annualized stock market return of 7 percent or higher and Vanguard is right about the potential for a return of 4 to 6 percent, those planning to retire in less than 10 years will need to either save more for retirement or extend out the date of retirement.

This reality may already be setting in among millions of pre-retirees as they watch friends and family members who have already retired tighten their belts as a result of an unprecedented, prolonged low rate of return for fixed income investors. Retirees who were earning 4 and 5 percent on U.S. Treasury securities or Certificates of Deposit prior to the financial crash in 2008 have seen their interest income cut by half or more since the crisis.

According to Vanguard’s new report, bond yields are not likely to see any significant uptick next year. The report notes: “And despite the risk for a short-term acceleration in the pace of monetary policy normalization, the risk of a material rise in long-term interest rates remains modest. For example, our fair-value estimate for the benchmark 10-year U.S. Treasury yield remains centered near 2.5% in 2018.”

The low yield in Treasuries, CDs and quality corporate bonds has obviously fueled at least part of the runup in stock prices, leading to what many believe is an unsustainable stock bubble.

Another hurdle for retirees is nailing down how much the fees embedded in their mutual funds in their 401(k) plans are draining from their retirement savings.

John Bogle is the legendary founder of Vanguard and served as its Chairman and CEO from 1974 to 1996. In 2013, he appeared on the PBS program, Frontline, to share an amazing bombshell: If you work for 50 years and receive the typical long-term return of 7 percent on stock funds in your 401(k) plan and your fees are 2 percent, almost two-thirds of your account will go to Wall Street.

Titled The Retirement Gamble, the Frontline program was written by the outstanding team of Martin Smith and Marcela Gaviria. The conversation between Bogle and Smith, who also served as moderator, went like this:

Bogle: Costs are a crucial part of the equation. It doesn’t take a genius to know that the bigger the profit of the management company, the smaller the profit that investors get. The money managers always want more, and that’s natural enough in most businesses, but it’s not right for this business.

Smith: Bogle gave me an example. Assume you’re invested in a fund that is earning a gross annual return of 7 percent. They charge you a 2 percent annual fee. Over 50 years, the difference between your net of 5 percent — the red line — and what you would have made without fees — the green line — is staggering. Bogle says you’ve lost almost two thirds of what you would have had.

Bogle: What happens in the fund business is the magic of compound returns is overwhelmed by the tyranny of compounding costs. It’s a mathematical fact. There’s no getting around it. The fact that we don’t look at it— too bad for us.

Smith: What I have a hard time understanding is that 2 percent fee that I might pay to an actively managed mutual fund is going to really have a great impact on my future retirement savings.

Bogle: Well, you have to rely on somebody to get out a compound interest table and look at the impact over an investment lifetime. Do you really want to invest in a system where you put up 100 percent of the capital, you the mutual fund shareholder, you take 100 percent of the risk and you get 30 percent of the return?

Smith brings up a compounding calculator on his laptop. He shows viewers the results:

Smith: Take an account with a $100,000 balance and reduce it by 2 percent a year. At the end of 50 years, that 2 percent annual charge would subtract $63,000 from your account, a loss of 63 percent, leaving you with just a little over $36,000.

Wall Street On Parade double-checked Bogle’s math. We pulled up a compounding calculator on line. We assumed an account with a $100,000 balance and compounded it at 7 percent for 50 years. That results in a balance of  $3,278,041.36. Next, we changed the calculation to a 5 percent return (reduced by the 2 percent annual fee) for the same $100,000 over the same 50 years. That delivered a return of $1,211,938.32. That’s a difference of $2,066,103.04 – the same 63 percent reduction in value that Smith’s example showed.

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