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
- Returns are total returns which assume you reinvest dividends and interest. [↩]
Just wanted to post to thank you for the retirement posts this week. They’ve been really informative and helpful, and will act as a great reference when reviewing my pension plans from time to time…
That’s great news, Jonny. I’m glad it’s useful stuff, otherwise there wouldn’t be much point.
In the advanced options of that calculator, you can also play with the levels of fees. As you’d expect, 1% fees is the same as 1% less return, which is why keeping fees as low as possible is important.
Inflation deceives to flatter all pension projections
I put the real 5% return on equities and a guessed real 1.5% return on a basket of bonds (in normal markets conditions) for someone starting a pension at 30 and retiring at 65 with a risk curtailment strategy starting at 50 into the liefstyling tool linked above
2/3 of the inflation adjusted value of their fund came from their contributions, only 1/3 came from investment gains
Its all about how much you save, how early you start and not paying fees
Hi TA,
Nice thought provoking series. I am concerned at this assumption that bonds reduce risk. In the present situation bonds are highly risky…..I recommend a read of “The Bond Conundrum” on the Hargreaves Lansdown website. You might also have caught the Telegraph story that M&G have sent a memo to their agents telling them to stop selling their bond funds. They could be worrying about a misselling scandal if the bond market crashes.
Even in “normal” situations the safety of bonds is greatly overplayed. Risk, in the investment sense, is just volatility. As Jeremy Siegel shows in “Stocks for the Long Run” bonds only have a lower volatility than stocks over a fairly short investment period. Once the investment timeframe is over 10-15 years equities are no more, and even less, volatile than bonds.
In return for the perceived safety of bonds the investor accepts a greatly reduced investment return. The average real return on UK stocks from 1900 to 2006 was 5.6%pa. On government bonds it was 1.3%pa. (data after Siegel). That is a 15yr real profit for stocks of 125% vs 22% for bonds.
In reality the situation is even worse as the dreaded expenses take, proportionally, a bigger chunk out of the profits. The mantra of moving out of stocks into bonds as you get older seems to me to be no more than that, a mantra. Even when you retire you still expect (or hope) to have investments for the next 20 or 30 years.
With only a 10% allocation, I am very light on bonds given how (hopefully!) close to retirement I am. However, I am using corporate bond ETFs to give me agility with low fees, and I’m using some lower volatility equities to further reduce volatility.
I’ve really enjoyed the retirement special on Monevator this week – much food for thought! Thanks! 😀
I’ve also enjoyed this series, it’s fantastic- well done!
Interesting thoughts on life styling Paul S, I have always wondered ho much sense it makes to move money into bonds when the key to riding out volatility in equities is to keep things in there for longer…
Say you invest at 30 into equities then that money after 30 years theoretically should be safe as you have ridden out potential drops that would affect the value, even if there is another drop and got an equity return. By constantly moving that money towards bonds you in effect take away the chance of the higher return.
It seems to me that maybe only new money should be slowly allocated to bonds or some similar strategy but at the moment I’m not sure what! trying to be too clever usually doesn’t work out well for me!
Ignore MG news by the way as Richard Wollnough(?), the don there, poo pooed that comments and said he can still make money, its just their bonds funds have got too big to manage.
Thanks for the positive comments, guys, glad you enjoyed the series!
We covered the bond conundrum quite recently. I currently own zero government bonds, and I feel safer for it. I think cash is a sensible alternative for more actively-minded investors, or even passive ones prepared to get a bit hands on.
However as I’ve said before I think we shouldn’t overplay the risk. If I buy a ten-year UK government bond today and hold until it matures, I am guaranteed to make a positive (nominal) return on the gross redemption yield. That is very different to equities, where there are no guarantees. That is why bonds reduce risk, in any environment.
Are they an attractive investment? Not for me, not at all, but for many they are there to do a job. (Protect against deflation, principally. See Japan).
Also, it may seem obvious bonds are ludicrously over-valued, but they can get more ludicrously over-valued. I first worried about a government bond bubble forming in late 2008! Even though shares have indeed done better, the fact is government bonds have done well, too.
It’s four years on and it may seem more obvious now, but little (especially timing!) is ever a slam dunk in the markets, IMHO.
@ Geo and Paul S – your money is never safe in equities. If you’ve done really well then a move into government bonds takes some of that risk off the table. If you’ve done really badly but can’t afford to lose any more then again, bonds are one way of reducing risk. Bear in mind, reducing risk (i.e. reducing volatility) does not equate to safety.
It’s better to think of the issue in terms of your overall portfolio rather than banking the farm on the asset class with the greatest chance of high returns. There’s no reward without risk.
A mix of equities and bonds is more diversified and helps protect you against a scenario like deflation or Japan or even just a bad few years for equities.
Equities less volatile than bonds? Only in terms of the historical average. In terms of what your portfolio could do this year, equities could plunge 30% whereas it’s highly unlikely government bonds would experience a fall into double figures. That’s why bonds belong in the portfolio of anyone who’s likely to panic in the face of a major market tailspin. With any luck your gilts will be your parachute.
Bond market crashes are not like stock market crashes. Take a look at this piece by Vanguard to see how quickly your bond allocation is likely to recover:
https://advisors.vanguard.com/iwe/pdf/ICRROL.pdf?cbdForceDomain=true
Thanks for these scenarios, the one you’ve outlined above is spookily familiar to me. I’ve been playing with the fund calculator most of the afternoon and I can conclude I need a bigger salary 🙂
For the record, I’m not so sanguine about gilts as my esteemed co-blogger. 🙂 A 1% rise in the ten-year rate would knock about 10% off the price of the gilt at these low yield levels, by my estimates. A swift rise to 4% could knock off 20% of the value of a ten-year gilt. I don’t think gilts at 3% is beyond the realms of possibility within the next couple of years.
You can model your own doomsday scenarios using this handy calculator.
This doesn’t change my overall view that passive asset allocators shouldn’t suddenly flee the asset class, or that it’s not helpful to talk about gilts as being ‘risky’ in the same sense as equities. It’s all about certainty (okay, very near certainty!) of capital return and income.
UK Gilt Treasury Stock 2021 currently has a price of 118.76. It will redeem at 100, so the capital loss is baked in, and indisputable. The redemption yield is 1.6 per cent though, which implies a positive return of 1.6% per annum if held to maturity, thanks to reinvesting the annual coupon.
1.6% per annum over a little under 10 years isn’t my idea of a great return (and as I say I don’t own any gilts) but it is secure.
TI, That is a secure nominal 1.6%pa which is almost certainly a secure real loss. Probably about -1%pa or so. Not the investment result I am looking for……..
Historically, I believe FTSE 100 has delivered around 6.5%/annum with dividends reinvested, however given it seems to have maxed out at 7000 since the turn of the century, I suspect it is probably closer to 4-5%/annum these days. However, I believe in that the next 10-15 years the FTSE100 will hit 10000 (even if it drops to below 5000) on the way. So growth should exceed 7%/annum in this period. With this sort of growth and associated volatility, you will need to pay close attention to the lifetime allowance of £1 million. May even be worth turning most of the pot into cash until you are over 75. It’s ironic that these changes could encourage more risk taking at an age when less should be taken.