What average pension growth rate should you use when trying to achieve your retirement goals? A comfortable retirement depends on not being too optimistic about what your pension funds can deliver.

Unrealistic assumptions can put your plans in peril. You can see this by experimenting with different pension growth rates in a retirement calculator.

An over-optimistic pension projection

Growth rate 9% per year over 35 years.
Projected retirement income = £27,000 p.a.

High return (9 per cent) pension projection = healthy annual retirement income of £27,000 after 35 years of investing £425 a month. 

A historically realistic pension projection

Growth rate 7% per year over 35 years.
Projected retirement income = £14,000 p.a.

Medium return (7 per cent) pension projection = a tight retirement income of £14,000. You’ll need to increase your £425 monthly contributions if that income falls short of how much you need to retire  

A low growth pension projection

Growth rate 5% per year over 35 years.
Projected retirement income = £7,000 p.a.

Low return (5 per cent) pension projection = a poor retirement income. The main remedy when returns are this low is to increase monthly pension contributions so you can reach the income you need. 

As you can see, changing the annual average pension growth rate leads to massive differences in final incomes.

The worst mistake you can make is to base your retirement plans on an unrealistic growth rate. If your pension fund returns fall short then you won’t have put enough away to meet your income needs.

What’s a realistic average pension fund growth rate?

Sadly, short of being mates with Dr Who, there is no way of knowing your future returns.

We can speculate about what might happen.

• Years of dystopian low growth as the world deglobalises?
• Or a golden age of AI-generated miracles powered by hydrogen and the blockchain?

Pick your forecast!

A more practical method is to use long-term historical returns. With over one hundred years of data to call upon, historical returns are a reasonable  gauge of market behaviour through thick and thin.

This approach doesn’t tell us what will happen – it offers us no guarantees whatsoever – but it does inform our pension planning with a more realistic baseline.

Using historical returns

The longest-term, average annualised return you can get is the number to use.

• The UK equity average annualised return1 is 5.4% from 1900-2021.
• Global equity annualised returns are around 5.3% over the same period.
• Those numbers are real returns – meaning they strip out inflation.
• Most retirement calculators assume nominal returns. They expect growth rates to include an inflation estimate.
• So you could add an average inflation expectation of 3% to the real returns above.
• That gives you an 8.3% global equities growth rate for your retirement calculator.
• However, it’s important to use asset return numbers that reflect your actual portfolio composition.
• And few investors can stomach 100% equities as they get older. Our risk tolerance tends to decline with age.
• UK government bonds have delivered an average annualised real-return of 1.8% from 1900-2021.
• That means a more typical 60/40 portfolio (60% equities / 40% bonds) has historically achieved around 4% after inflation.
• So 7% (4% real return + 3% inflation) is a reasonable average pension growth rate based on historical returns.

Are there any alternatives?

Yes, one approach is to use expected returns. They’re typically based on current market valuations.

The equations that underlie expected returns adjust for influential factors like whether the market is considered to be over- or under-valued.

These predictive models aren’t necessarily more accurate than using historic returns. But they’re a very useful second opinion. Especially when markets are thought to be over-valued – as they are now.

Many commentators forecast that high valuations mean we can expect future returns to be lower than in the past.

This FCA report sets out the case for lower annual real returns over the next 15 years.

It assumes 4.5% for equities and -0.5% for government bonds.

You can also construct your own, up-to-date, expected returns for every asset class in your portfolio. This post on the Gordon Equation shows you how.

Remember: the higher your rate of return, the greater the risk that the markets will fail to deliver. Err on the side of caution.

Asset allocation and likely returns

You can influence your average pension growth rate by changing your asset allocation.

Devoting a higher percentage of your portfolio to a diversified range of equities will increase your prospects for higher growth.

This move increases risk.

The less risk you can tolerate, the more you need to dampen down your portfolio’s volatility with government bonds. But increasing the amount of bonds in your portfolio lowers your prospects for growth over time.

This trade-off is the nub of investing.

Ultimately, whatever average pension growth rate you choose, the reality will probably prove quite different. Prepare to adapt over time by adjusting your plan’s key components.

And be sure to consider all the other aspects of retirement planning to put yourself in the best possible position.

Take it steady,

The Accumulator

1. Returns are total returns which assume you reinvest dividends and interest. [↩]

Bit of a ramble about the news, feel free to skip to the links below.

I was writing a follow-up on investing in the face of regime change when it began to look overwhelmingly likely that Russia would invade Ukraine.

My previous articles covered how quantitative tightening and the return of inflation could change the landscape for investors. Now Russia was set on redrawing maps the old-fashioned way.

Suddenly paragraphs on why you should still hold government bonds in case of shocks or reasons not to go all-in on equities didn’t look academic.

And how would the conflict unfold?

I held off completing my article, and like everyone I turned to watching the news.

War

Russia crossed into Ukraine. Markets fell. Bonds rallied a bit.

Most investing pundits were sanguine. They shared graphics like this one from Ryan Detrick:

(Click to enlarge the drama)

I wondered when we should do something similar. Traffic to Monevator had dwindled due to the sudden news-binge. But experience tells me investors can get spooked by geopolitical events.

Though everyone knows this these days.

So pundits on Twitter waved aside worry and talked up a buying opportunity. After a nod to the human tragedy, financial TV commentators debated the merits of energy firms versus cybersecurity outfits. And so on.

I have no problem with this. Sure it can look ugly in the moment. People complained about heartless traders during many of the latter events in the table above.

But there’s nothing to be gained by capitalism shutting down in the face of geopolitical horror. And it’s not like 99% of us are in any position to influence events, if only we could tear ourselves away from our brokers.

You might question someone’s priorities. But I don’t think it’s a question of morality.

Relax

No, something else was bugging me about all this talk of filling your boots on war.

It crystalized when I heard a couple of American bloggers waving away concerns by comparing the GDP of Russia to the (larger) economic output of Texas.

Again that was true. But as I retorted this missed something important:

Attention younger members of #fintwit. It’s true that Russian’s GDP (c.$1.5tn) is less than Texas’s GDP (c.$2tn)

But Texas does not have c.5,000-7,000 nuclear warheads in various states of repair capable of ending the world in the next ten minutes

This is “why it matters” 😐

— Monevator (@Monevator) February 24, 2022

We can debate which geopolitical events of the past few decades realistically might have put nuclear Armageddon onto the board, however unlikely.

But I think you have to go back to the 1960s for it to be a potential feature of conflict, not a bug.

Rage Hard

Maybe I’m showing my age, but these younger commentators mostly didn’t seem to get it.

Of course I fully agree that in a scenario where both sides launch nuclear bombs you may as well own shares versus bonds. Because who cares when the planet is in rubble?

Once you acknowledge that, the nuclear question is moot.

And perhaps all these chipper dip-buyers had already done that calculus.

But I doubt it. I don’t believe most gave it any thought, especially early in the week.

As child of the early 1970s, I well remember talk of four-minute warnings and visions of hiding under the kitchen table when you hear the siren. The relief when treaties reversed the expansion of the nuclear arsenals. The fall of the Iron Curtain that the Russian leadership now laments.

The reality is Russia could roll-up Ukraine and Belarus and Lithuania and reinstate its buffer with the West and we would be basically powerless to stop it.

Will we take the annihilation of London or Berlin in exchange for defending Vilnius? Of course not.

Again as a middle-aged bloke who has read my fair share of military histories I am well-versed in the counter-argument. Mutually Assured Destruction (M.A.D.) doctrine tells us neither side will act to start a nuclear war because nobody will win. Many say this is what has kept the peace in Europe since World War II.

Only this isn’t keeping the peace in Europe this morning. Russian troops are in Kyiv, with at least 1,500 ready-to-go nuclear weapons at their back.

Two Tribes

How should this change how you invest?

Barely, if at all, especially if you’re a passive investor.

All correlations between asset classes go to one in a worst-case scenario. (Good luck verifying your blockchain too).

But in that scenario the Great Filter does its job and Earthlings won’t have to fret about rising bond yields again for a few hundred years, if ever.

Therefore it’s only rational to ignore the worst outcome from your planning.

And so whether tough-talking or naive, those pundits were right. Take it out of the equation. Buy any panicky dip.

Sure enough the market went on a bender before the conflict had barely begun. Early losses reversed. Gold fell too. Many of my individual stocks ended the week higher than they started.

Again, all the theories. Falling bond yields meant it was now safer to buy growth stocks (except yields didn’t fall much). Central banks would raise rates more slowly. (Again, only the slightest nod to that in the data). The sanctions turned out to be too weak to cripple the European economy through friendly-fire. (The likeliest candidate for the rally, in my view). The West was galvanizing and that was good for future returns. The economy would slow sooner, and maybe that was good too. (Because, again, lower rates).

Russia was bogged down, and had proven itself weak. Russia had shown it would win quickly, and the war would be short-lived.

Who knows.

Warriors of the Wasteland

Like Matt Klein (and as I wrote a few week’s ago when bemoaning the distraction of Brexit) I have long fretted about how we’ve enabled a menace on our doorstep.

For example Germany shut down its nuclear reactors in a burst of progressive righteousness after Fukushima – only to become more dependent on a dictatorship with ambitions to produce the worst-ever sequel to Back to the Future.

As Klein writes:

The perverse result is that Europe is at greater risk of Russian pressure than the other way around. Natural gas prices in Europe are now about 5-6 times as high as in the U.S. because Gazprom has been withholding supply and because the lack of LNG terminals has prevented ships from moving gas across the Atlantic.

And while Europeans have made some modest investments in solar and wind energy over the past decade, it hasn’t been nearly enough to make a dent in the overall energy mix, especially after factoring in the impact of the decisions to decommission existing nuclear power plants.

The Europeans seem to have – belatedly – realized the implications of all this.

The Cold War was hard won. It cost blood and treasure.

Yet we seem to have forgotten that the world is a dangerous place, whether living out little England fantasies and electing dangerously failed property developers on the one side, or canceling writers for what a goblin said in a fairy story on the other.

A could-have-been unifying global pandemic only made things worse.

I have a bug-out plan for some less-than-worst case scenarios. Do you?

Have a good and safe weekend.

[continue reading…]

A big blank on the personal finance map is paying for long-term social care. By that I mean how we’ll fund care for ourselves and loved ones if we need support to cope with serious physical and mental deterioration in later life.

• Think the threat is thwarted by the UK’s new Health and Social Care Levy? It’s not.

• Maybe you think it’s taken care of by the NHS? It’s not.

• You might think: “That’s a bridge I’ll cross when I come to it.”

Yeah, that last one was my approach.

I stuck my worries in a box labelled: Too complicated. Too scary. Too far away.

Then I buried it in the psychological sand.

It could be you

Avoidance is not a strategy, however – especially in the UK.

Increasing need, rising costs, squeezed budgets, and political prevarication means that in Britain the expense of long-term social care falls disproportionately on those unlucky individuals who require the most help.

• How will we pay for our care if the worst happens? Sell the house? Is there an alternative?

• How do we hedge against the chance that we may not need long-term care? I don’t want to save huge sums for something that never happens.

• What State-funded support is actually available?

• Are there smart ways to deal with means tests when we’re assessed for support?

The answers are out there. And now that I’ve looked inside the box, I think long-term social care can and should be planned for.

At the very least, it seems less scary than when it lurked like a death star on the fringes of my mental and financial map.

Strap in for a bumpy ride

The UK’s patchwork of social care funding options makes for a big topic.

In this post, I’ll explain why you’re likely to pick up the bulk of the tab – regardless of those headline-grabbing social care caps.

In later posts we’ll cover:

• How does social care means-testing work? Which assets are included and excluded?

• What care is not means-tested?

• Can we devise a rule-of-thumb figure for social care to plug the black hole in our financial plans?

• How do you pay for social care? What are the options – with an emphasis on those that avoid selling the house from under anyone you care about?

Social care funding thresholds

The social care funding thresholds help illustrate why you’ll probably pay for some or all of your care:

Your financial assets are means-tested when you seek local authority support1 for your care.

If your assets are valued:

Above the upper threshold – You pay for your care. You’re a self-funder in the jargon. At least until your assets are so depleted that you fall under the threshold.

Separately you may be entitled to limited support via the NHS. But don’t count on it.

• Scotland and Northern Ireland make personal care services universally available. These aren’t means-tested. You may well need to pay for other home care services, though.

Between the thresholds – You’re eligible for some local authority financial help but also need to contribute from your own assets and income. I’ll deal with the impact of that formula later in the series.

(Between the thresholds doesn’t apply in Wales.)

Below the lower threshold – You qualify for more funding but it’s not unconditional. You’re still liable to pay from your income (which includes benefits and the State Pension) above yet another minimum threshold.

Which brings me to the salient point about social care funding.

Nothing is as it seems.

• Being eligible for care doesn’t mean it will be funded.

• Funding from your local authority doesn’t mean all your social care bills will be paid.

• Even if you qualify for financial assistance, there can and likely will be a gap between the care the State will pay for and the care you want.

A maze, hidden in a labyrinth, inside a jungle

Navigating the social care system is like dealing with a second tax code.

Even terms like ‘personal care’ in the table above refer to a defined set of services that don’t encompass everything you may need.

You also have to be assessed as needing specific types of care to stand a chance of receiving a service for free. That’s trickier than it sounds.

Whether your home falls into the means-tested mix depends on other conditions. We’ll explore those later in the series.

The thresholds also have a habit of not moving with inflation. The upper threshold for England hasn’t shifted since 2010/11.

Meanwhile, the real (after-inflation) cost of care in the home has risen by 10.6% since 2015/16 and care home places by 12% over the same period, according to healthcare charity The King’s Fund.

Unlucky for some

The anti-bonus ball in all this is a postcode lottery effect. This sees outcomes vary widely by local authority and region.

Personal funding shortfalls in England can be exacerbated by the North / South divide, for example.

Local authorities in the North tend to pay lower rates for services than those in the South.

Moved south to be closer to family after entering the system? That could make it more difficult to cover social care expenses.

Multiply all this complexity by different systems in each of the home nations and you have a throbbing headache.

No wonder most of us hope the problem just goes away.

The next section illustrates why the new social care cap in England is no wave of a magic wand. While less relevant to readers living in the other home nations, it does reveal some of the traps to be wary of throughout the UK.

The social care cap – why it doesn’t fix the problem

England’s new social care cap comes with more strings than a puppet show.

The centrepiece is an £86,000 lifetime cap on social care costs.

Once your spending hits the cap, the local authority is meant to take over paying for your care. This is a universal benefit. No means-testing required.

But the devil is in the detail and he’s up to no-good.

In reality there’s a range of care expenditures that don’t count towards your cap.

Your spending can shoot far beyond £86,000, yet your metered tally shows you falling short. This forces you to keep spending because you haven’t ‘officially’ reached the cap.

Even if you do hit the cap, the expenditure exclusions can leave with you bills to pay after your local authority steps in.

The impression that your social care expenditure is capped at £86,000 is ‘technically’ the case in the same sense that attending office parties during a pandemic is ‘technically within guidelines’ – if you ignore the real world.

Let’s walk through the main loopholes. (Because they’re that big.)

Daily Living Costs (DLCs)

Firstly, £10,400 per year of care home fees don’t count towards the social care cap. The idea is that an individual remains responsible for their food, board, and utility bills, before and after they’ve hit the cap.

DLCs put a flat rate figure of £200 per week on this responsibility.

Local authority care discounts

Imagine you need to go into a care home. It costs you £700 per week because you don’t qualify for financial support i.e. you’re a self-funder.

But the same care, in the same home, costs your local authority £500 per week – because they negotiate a better deal for residents they’re obligated to support.

Guess which figure counts towards your social care cap?

Did you guess the lower £500 per week – despite the fact the care you’re getting actually costs you 40% more?

Oh, you complete and utter cynic.

Yeah, you’re absolutely right.

But you’re not quite cynical enough! Because you must also deduct the £200 per week from those DLCs.

In this example, only £300 per week counts towards your cap. Your total spending won’t reach the cap for five and a half years.

Care home fees paid by self-funders are 41% higher, on average, than costs paid by local authorities for places in the same care homes. That’s according to figures quoted by The King’s Fund.

Qualify for any State support before you hit the social care cap? That money doesn’t contribute towards your £86,000 total, either.

Only money that you contribute from your own pocket counts. Minus the premium you pay as a self-funder. Minus payments for services your local authority deems unnecessary.

Care needs assessment gaps

Only spending on your eligible care needs counts towards your social care cap.

Only eligible needs will be funded by your local authority once you hit your cap.

Your eligible needs are determined by a care needs assessment. And who runs that? Local authorities.

These are the same local authorities that suffered a 55% cut in government funding between 2010/11 and 2019/20, according to The Kings Fund.

The BBC reports that half of requests for help are turned down.

Budget pressures are one reason why your local authority may think you need less care than you do.

Pay as you go

As a self-funder you can of course pay for all the care you can afford.

After you hit the cap, you can keep paying for care beyond your eligible needs using top-ups. If you have the money.

The bigger the gap between your needs and what’s deemed eligible, the more you’ll pay out-of-pocket.

For example, you may want to pay for additional care services in your home. Or perhaps for more hours of help with cooking meals than your local authority deems necessary.

In a care home, you may want a bigger room with more facilities than the council will stump up for. You may also be charged for extras – anything not covered by your official resident’s care plan.

You may start self-funding a care home place but become eligible for support later. That can leave a funding gap if your local authority will only pay for a cheaper home but you want to stay put.

Or you may wish to move closer to loved ones – who live in a more expensive part of the country – after your needs were assessed in a cheaper region. You’d have to pay the difference if the council refuses to increase your funding.

There are still more exemptions, but you get the point.

The cap doesn’t fit

The reality is you can rack up large social care bills that don’t trigger the cap.

Even if you do qualify for financial support, there can be a gulf between what you need and what the State will pay for.

And I haven’t even covered the inequities of the social care formula that penalise homeowners in areas with low property prices.

This Is Money has an excellent piece on that. It includes a damning verdict from Andrew Dilnot, who chaired an independent commission on social care from 2010 to 2011.

The bottom line is that if your house is your only spare asset, then selling it to fund long-term social care remains a live threat.

The good news is that there’s little chance you or a significant other will end up homeless. There are plenty of deferred payment and equity release options available. We’ll look at those in a later post.

But in part two of the series, I’ll cover how your assets are assessed in the social care means test.

Take it steady,

The Accumulator

1. Health and Social Care Trust in Northern Ireland [↩]