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©2016 Morningstar, Inc. All rights reserved.
David Blanchett, CFA, CFP®Head of Retirement ResearchMorningstar Investment Management, LLC
Estimating the True Cost of Retirement
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Agenda
2
Retirement
For illustration only.
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Relative Importance
3
Retirement
Home
For illustration only.
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4
Two Sides of the Equation
Liabilities
Assets Liabilities
For illustration only.
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5
Assets
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6
For illustration only.
The Past as a Guide
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7
Stocks, Bonds, Bills, and Inflation 1926–2013
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8
Source: Ibbotson
Stocks Return 10% Per Year?
-10%
-5%
0%
5%
10%
15%
20%
25%
Dec-35 Aug-49 Apr-63 Dec-76 Sep-90 May-04
10 Y
ear A
vera
ge A
nnua
l Com
poun
ded
Real
Retu
rn fo
r the
S&P
500
10 Year Period Ending
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9
For illustration only. Source: Author’s Calculations.
How Much Do I Have to Save for Retirement: the 4% Rule
$0
$20,000
$40,000
$60,000
$80,000
$100,000
1 4 7 10 13 16 19 22 25 28
Inco
me
Retirement Year
InflationAdjustments
Initial Income
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10
Where the 4% Rule Comes From… Historical US Data
0%
2%
4%
6%
8%
10%
12%
14%
1900 1910 1920 1930 1940 1950 1960 1970 1980
Initial Sustainable Withdrawal Rate
Retirement Year
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11
Average annual compounded real return for a 60% stock, 40% bond portfolio: 1900 – 2013. Source: Dimson, Marsh, and Staunton, Morningstar Direct.
An International Perspective on Historical Returns
2.72%
1.84% 2.34%1.28%
4.06% 5.01%
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12
An International Perspective
0%
2%
4%
6%
8%
10%
12%
14%
1900 1910 1920 1930 1940 1950 1960 1970 1980
Initi
al S
usta
inab
le W
ithdr
awal
Rat
e
Retirement Year
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13
An International Perspective
0%
1%
2%
3%
4%
Austr
iaAu
strali
aBe
lgium
Cana
daDe
nmar
kFin
land
Fran
ceGe
rman
yIre
land
Italy
Japa
nNe
therla
nds
New
Zeala
ndNo
rway
South
Afric
aSp
ainSw
eden
Switz
erlan
d UK US
Initi
al Sa
fe W
ithdr
awal
Rate
99% Success Rate 95% Success Rate 90% Success Rate 80% Success Rate
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14
Source: Robert J. Shiller
Where Are We Today?
05101520253035404550
02468
10121416
1881 1931 1981
CA
PE R
atio
Bon
d Yi
eld
Year
10 Year Government Bond Yields Shiller CAPE Ratio
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15
Source: Ibbotson
Bond Yields and Future 10 Year Bond Returns
y = 0.9466x + 0.0084R² = 0.9203
0%
3%
6%
9%
12%
15%
0% 3% 6% 9% 12% 15%
Aver
age A
nnua
l 10 Y
ear F
utur
e Co
mpo
unde
d Bo
nd R
etur
n
Current Bond Yield
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16
Source: Robert J. Shiller
CAPE Ratios and Future 10 Year Stock Market Returns
y = -0.0035x + 0.1461R² = 0.2384
0%
4%
8%
12%
16%
20%
5 10 15 20 25
Futu
re 10
Yea
r Ann
ualiz
ed R
etur
n
CAPE Ratio
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17
A ‘Build Up’ Approach to Forecast Asset Class Returns
Credit spreadTerm spreadReal RateInflation
Equities Fixed Income
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18
Our Best Guess on Returns (2015 CMAs)
Asset Class 1-10 11-20 20+ 1-10 11-20 20+US Large Cap Growth Equities 3.32 7.14 7.24 0.98 4.80 4.90US Large Cap Value Equities 3.95 8.67 8.78 1.86 6.58 6.69US Mid Cap Equities 3.93 9.15 9.28 1.68 6.90 7.03US Small Cap Equities 3.68 9.08 9.21 1.22 6.62 6.75US REITs 2.99 8.81 8.91 0.57 6.39 6.49Intl Equities 6.30 7.54 7.63 4.02 5.26 5.35Emerging Markets Equities 10.48 9.76 9.90 7.78 7.06 7.20Long Term Bonds 0.77 1.91 3.91 -0.88 0.26 2.26Intermediate Term Bonds 0.38 1.92 3.04 -0.76 0.78 1.90Short Term Bonds -0.16 1.60 2.69 -1.10 0.66 1.75High Yield Bonds 1.92 4.12 5.66 0.24 2.44 3.98Intl Bonds -0.22 2.42 3.93 -1.89 0.75 2.26Cash -1.06 0.58 1.02 -1.74 -0.10 0.34
Arithmetic GeometricSimulation Years Simulation Years
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19
Source: “Low Bond Yields and Efficient Retirement Income Portfolios” by David Blanchett, Journal of Retirement
The Safety of The 4% Rule, Past versus Future
57%
79%90% 93% 93% 93% 93% 92% 91% 90% 88%
3%8%
21%
37%49%
56% 61% 64% 65% 65% 64%
0%
20%
40%
60%
80%
100%
0% 20% 40% 60% 80% 100%
Prob
abili
ty o
f Suc
cess
Portfolio Equity Allocation
Historical Returns Model Forecasted Returns Model
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20
Is 4% Safe?
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21
Source: “Low Bond Yields and Efficient Retirement Income Portfolios” by David Blanchett, Journal of Retirement
A More Colorful Perspective of 4%
0%
2%
4%
6%
8%
10%
12%
65 70 75 80
4.8%4.0%
6.1% 5.7%4.9%
7.7%
10.0%
Age
Withdrawal Rate
5.3%
6.6%5.7%
9.1%
6.5%
MaleFemaleJoint
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22
The Retirement Liability
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Common Liability Assumptions
23
80% 30 years
Replacement Rate
Retirement PeriodNeed Change
Inflation
For illustration only.
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24
Replacement Rate
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25
Source: “Estimating the True Cost of Retirement” by David Blanchett, White Paper
Estimating a Replacement Rate
ConsumptionSmoothing
Expenses ChangeAt/During Retirement
$Income Differences
$
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26
Earnings Curves
$1.00
$1.20
$1.40
$1.60
$1.80
$2.00
$2.20
25 35 45 55 65Aver
age
Life
time
Gro
wth
in R
eal W
age,
Age
25
= $1
AgeHigh School College Advanced
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27
Source: “Replacement Ratio Study” by Aon Consulting
Replacement Rates For Various Households
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28
Retirement Consumption
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What Drives Retiree Spending?
29
W hat They Buy(Consumption Basket)
How Much the Spend
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30
For illustration only.
The Retirement Consumption Puzzle
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31
Source: “Estimating the True Cost of Retirement” by David Blanchett, Morningstar White Paper
Expenditures as a Percentage of Total Household Consumption by Age
0%10%20%30%40%50%60%70%80%90%
100%
25 30 35 40 45 50 55 60 65 70 75 80 85
% o
f Tot
al
Age
Other
Transportation
Insurance & Pensions
Housing
Healthcare
Food
Entertainment
Clothes
Charity
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32
Source: “Estimating the True Cost of Retirement” by David Blanchett, Morningstar White Paper
Medical Spending for Different Income Levels
0%
10%
20%
30%
40%
50%
60 65 70 75 80% o
f Tot
al E
xpen
ditu
res
Age
Low Income Mid Income
0%
10%
20%
30%
40%
50%
60 65 70 75 80% o
f Tot
al E
xpen
ditu
res
Age
Low Income Mid Income
Median Spending Highest 1 in 20 Households
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General Inflation (CPI-U) versus Medical Inflation
33
gMedical inflation has averaged +5.42% per year from 1948 to 2012, versus +3.63% for the CPI-U, therefore, has been growing about 50% faster than general inflation
y = 0.7011x + 0.0288R² = 0.5907
0%
3%
6%
9%
12%
15%
-3% 0% 3% 6% 9% 12% 15%
Med
ical
Infla
tion
General Inflation (∆ in CPI-U)
Source: Bureau of Labor Statistics.
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Different Inflation Baskets
34
gFrom December 1982 to December 2012 the average annual change in the CPI-E has been 3.07% versus 2.92% for CPI-U
Expenditure group CPI-U CPI-W CPI-E CPI-W CPI-EApparel 3.5% 3.6% 2.4% 0.1% -1.1%Education and communication 6.7% 6.7% 3.8% 0.0% -2.9%Food and beverages 15.0% 15.7% 12.8% 0.7% -2.2%Housing 40.2% 39.2% 44.5% -1.0% 4.3%Medical care 6.9% 5.6% 11.3% -1.3% 4.4%Other goods and services 5.3% 5.1% 5.4% -0.2% 0.1%Recreation 5.9% 5.5% 5.3% -0.4% -0.6%Transportation 16.5% 18.7% 14.5% 2.2% -2.0%
∆ from CPI-UExpenditure Weights
Source: Bureau of Labor Statistics.
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2016 Inflation for Social Security Retirement Benefits
35
Source: Bureau of Labor Statistics.
CPI-W CPI-E CPI-UFood and beverages 1.45% 15.7% 12.8% 15.0%Housing 2.13% 39.2% 44.5% 40.2%Apparel -1.46% 3.6% 2.4% 3.5%Transportation -7.39% 18.7% 14.5% 16.5%Medical care 2.49% 5.6% 11.3% 6.9%Recreation 0.86% 5.5% 5.3% 5.9%Education and communication -0.34% 6.7% 3.8% 6.7%Other goods and services 1.74% 5.1% 5.4% 5.3%
-0.12% 0.43% 0.09%
Sept14-Sept15 ∆
Weighted Average
Weights
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Base Expectation of Retiree Spending???
36
Spending Increases Throughout Retirement(because of the changing consumption basket)
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Slow-Go: Between the ages of 70 and 84, brought on by the body saying “Slow Down,” 20%-30% budget decline.
No-Go: 85+, significant changes in retirement lifestyle is generally brought on by health issues.
Go-Go: Retirees maintain lifestyle, travel, the group that does not consider themselves "old".
37
Source: "The Prosperous Retirement, Guide to the New Reality", Michael Stein
Inflation Risk: The Three “Stages” of Retirement
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Annual Real Change in Expenditures for Retirees
38
R² = 0.3009
R² = 0.5702
-6%
-5%
-4%
-3%
-2%
-1%
0%
1%
2%
60 65 70 75 80 85 90
Ann
ual R
eal C
hang
e in
Tot
al
Expe
nditu
res
Age
Source: “Estimating the True Cost of Retirement” by David Blanchett, Morningstar White Paper
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39
Source: “Estimating the True Cost of Retirement” by David Blanchett, Morningstar White Paper
Lifetime Real Income Need, Age 65 Retiree
$0.5
$0.6
$0.7
$0.8
$0.9
$1.0
$1.1
$1.2
65 70 75 80 85 90 95
Ann
ual R
eal D
olla
r Cha
nge
in
Con
sum
ptio
n
Age
25k Spend 50k Spend 100k Spend
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Actual Retiree Spending
40
W hat retirees spend money on costs more
But they actually spend less
+ =
Spending declines… on average
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41
For illustration only.
Spending Less: Why?
Choice Necessity
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42
The Length of Retirement
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43
For illustration only.
Longevity Risk
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44
For illustration only.
Inefficient Retirement Planning
Defined Benefit Plans Defined Contribution Plans
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45
Life Expectancies Keep Increasing
10
15
20
25
1900 1950 2000 2050 2100
Life Expectancy (Years) for a
65 Year-Old
Year
Female Male
Source: Social Security Administration
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… but the Gains are being Realized M ostly by the W ealthy
1415161718192021222324
1912 1922 1932
Cohort life expectancy
at age 65
Year
Earnings in top half of distributionEarnings in bottom half of distribution
Source: Waldron (2007)
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… and Now a Large Gap Exists in Life Expectancies by Income Level
-4.6
-3.1-2.2
-1.5-0.9
0.01.2
2.13.3
5.5
-2.4 -2.0 -1.7-0.9
-0.1
0.4 0.8 1.11.8
3.1
-6
-4
-2
0
2
4
6
8
1 2 3 4 5 6 7 8 9 10
Difference versus Average Life
Expectancy for a 55-Year-Old
Income Decile
Males
(poorest) (richest)
Source: Bosworth and Burke (2014)
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7% 13% 1% 19%
20% 29% 6% 43%
Male Female Both ≥1
Average American
Healthy American
25% 33% 8% 50%Healthy American in 2028
48
Source: Social Security Administration, Society of Actuaries
What the are Odds?... The Probability of a 65 Year Old Living to Age 95
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Annuities… The Only Way to Guarantee Income for Life
49
For illustration only.
65 70 75 85 90 95 100
$Income
65 70 75 85 90 95 100
$Income
Immediate Annuity
Deferred Income Annuity
Age
65 70 75 85 90 95 100
$VA+ GLW B
Income
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50
For illustration only.
The Best Annuity Around
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A Better Retirement Spending Model
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52
For illustration only.
Building a Better Model
Spending Smile Changes in Spending Varies by Consumption Level
True Failure
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53
For illustration only.
Is this “Failure”?
$0
$2,000
$4,000
$6,000
$8,000
$10,000
1 2 3 4 5 6 7 8 9 10
Income Goal
Income Shortfall
Income Goal
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54
For illustration only.
What is Failure?
Failure Not Failure
Client Living StatusAlive Dead
â $
0<
$0
Portf
olio
Bal
ance Not Failure Not Failure
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Source: “Estimating the True Cost of Retirement” by David Blanchett, Morningstar White Paper
Probabilities of Success for Different Scenarios
25 30 35 Male Female Joint3.0% 98.9% 95.4% 89.6% 98.3% 97.5% 96.3%4.0% 88.4% 73.3% 58.5% 90.7% 87.0% 81.5%5.0% 61.0% 39.7% 26.3% 76.4% 68.6% 57.4%6.0% 29.9% 14.8% 8.1% 60.0% 49.3% 34.5%
25 30 35 Male Female Joint3.0% 99.7% 98.5% 95.6% 99.3% 99.0% 98.5%4.0% 94.8% 86.0% 75.4% 95.1% 93.0% 89.9%5.0% 75.9% 57.8% 42.8% 84.2% 78.5% 70.3%6.0% 45.3% 28.1% 17.2% 68.4% 59.2% 46.3%
Withdrawal Increases Annually by InflationFixed Period (Years) During Lifetime (Age 65)
Initia
l W
ithdr
awal
Rate
$50k Initial Goal CurveFixed Period (Years) During Lifetime (Age 65)
Initia
l W
ithdr
awal
Rate
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Retirement Satistfaction
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Are Retirees Happy? (Yes)
57
46%54% 58% 62% 62% 62% 57% 55% 56% 54%
36%33%
32% 31% 31% 32%35% 36% 37% 38%
18% 13% 10% 8% 7% 6% 8% 8% 7% 9%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
% o
f All
Ret
irees
HRS Survey Year
Not at allModeratelyVery
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Conclusions
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Tips/Takeaways
59
gUse expected returns in simulations… not historical… you can’t buy the past
gThe “4% Rule” isn’t nearly as safe data as historical data suggests using forward-looking projections
g Increase the expected length of retirement in your models… your clients aren’t “average” from a life expectancy perspective
/30+ years for a married couple both age 65
gConsider modeling different levels of spending in retirement, where inflation-adjusted consumption decreases as the retiree/s age
gRetirees are a relatively happy bunch… and it’s not the financial stuff that makes them the happiest
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Combined Impact of the Cost of Retirement
60
Projected returns are lower
Retirees spend less throughout retirement
+ =
Total cost is lower
Retirees are living longer
+
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Disclosures
61
The above commentary is for informational purposes only and should not be viewed as an offer to buy or sell a particular security. The data and/or information noted are from what we believe to be reliable sources, however Morningstar Associates has no control over the means or methods used to collect the data/information and therefore cannot guarantee their accuracy or completeness. The opinions and estimates noted herein are accurate as of a certain date and are subject to change. The indexes referenced are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results. The charts and graphs within are for illustrative purposes only.
Monte Carlo is an analytical method used to simulate random returns of uncertain variables to obtain a range of possible outcomes. Such probabilistic simulation does not analyze specific security holdings, but instead analyzes the identified asset classes. The simulation generated is not a guarantee or projection of future results, but rather, a tool to identify a range of potential outcomes that could potentially be realized. The Monte Carlo simulation is hypothetical in nature and for illustrative purposes only. Results noted may vary with each use and over time.
The results from the simulations described within are hypothetical in nature and not actual investment results or guarantees of future results. This should not be considered tax or financial planning advice. Please consult a tax and/or financial professional for advice specific to your individual circumstances.
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Questions
62