What average pension growth rate should you use when trying to achieve your retirement goals [1]? 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 [2].
An over-optimistic pension projection
Growth rate 9% per year over 35 years.
Projected retirement income = £27,000 p.a.
[3]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.
[4]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 [5]
A low growth pension projection
Growth rate 5% per year over 35 years.
Projected retirement income = £7,000 p.a.
[6]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 [7]. 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 [8] is 5.4% [9] from 1900-2021.
- Global equity annualised returns are around 5.3% [10] 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 [11] as they get older. Our risk tolerance [12] tends to decline with age.
- UK government bonds [13] have delivered an average annualised real-return of 1.8% from 1900-2021.
- That means a more typical 60/40 portfolio [14] (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 [15]. They’re typically based on current market valuations [16].
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 [17] 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 [18] 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 [19].
Devoting a higher percentage of your portfolio to a diversified range of equities will increase your prospects for higher growth.
This move increases risk [20].
The less risk you can tolerate, the more you need to dampen down your portfolio’s volatility with government bonds [21]. 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 [1].
And be sure to consider all the other aspects of retirement planning [1] to put yourself in the best possible position.
Take it steady,
The Accumulator
- Returns are total returns which assume you reinvest dividends and interest. [↩ [26]]