The False Promise of U.S. Historical Returns

Relying on only historical U.S. returns creates an unrealistic picture of retirement outcomes. Our analysis shows that U.S. data are an anomaly among the broader global universe, and that our low-yield environment forebodes lower-than-average equity returns.

Before we get into the details of those conclusions, let’s review why bond and stock return forecasts are so critical to the Monte Carlo methodology that is the basis for analyzing retirement plans.

A Monte Carlo Analysis is a statistical procedure that simulates a sequence of possible future investment returns. It is common to run a Monte Carlo analysis on hundreds or thousands of simulated retirements to estimate the impact of portfolio spending rates on the probability of running out of money. The projection typically assumes the withdrawal of a fixed amount each year from an investment portfolio that increases or falls by a random rate of return. It is common to base the distribution on historical U.S. returns on stocks and bonds.

If the return distributions of stocks and bonds resemble a bell curve, then most simulated returns will be close to their respective average. The estimated safety of a fixed-withdrawal strategy will not be accurate if the average assumed return in the Monte Carlo analysis is higher than the average return an investor is likely to experience. If the mean is a few percentage points lower than the historical average, these estimates can be very far off.

Real bond returns are likely to be significantly lower than their historical average over the next decade. Returns on risk-free bonds are a component of forecasted stock returns according to the capital asset pricing model (CAPM), meaning that lower bond returns should affect expected stock returns. Even if portfolio returns revert back to their historical average in subsequent decades, shifting the equity return distribution to the left at the beginning of retirement will have an outsize impact on outcomes.