Retirement: Three Big Questions

Question 2: How much will you earn on your investments?

It used to be that any college freshman who hadn't dozed through Economics 101 could tell you what investments will earn in the long run. Drawing on 85 years of market data compiled by the Chicago research firm Ibbotson Associates, everyone assumed U.S. stocks would earn about 10 percent a year on average; bonds, around 5.5 percent; and a half-stock and half-bond portfolio, around 8 percent.

Then came the "lost decade" of 2000 to 2009, when stock-market indexes went nowhere. How big a difference did that make? (Are you sure you want to know?) Suppose you had saved $500,000 by age 60. If all went according to Ibbotson, you'd have a bit more than $1 million in the bank by age 70. At today's annuity rates, that would buy you an annual income of $87,000 for the rest of your life. Not bad. But if you'd had the misfortune of turning 60 in 2000 — the dawn of the lost decade — you'd have reached retirement 10 years later with barely the same $500,000 you started with. Your annual annuity income from that sum today: just $39,000. Relying on Ibbotson averages for a retirement plan could be like following one of those medieval "Here Be Dragons" maps.

What to do? You can build in a margin of safety by plugging very low returns into your retirement calculators. Colorado Springs financial planner Allan Roth assumes a zero percent return after taxes and inflation. "That probably lowballs what a good investor could earn," he says. "But for most people, who have a lot of their return eaten away by fees and bad decision making, a return that equals inflation might even be a little optimistic."

Other planners and calculators don't even ask you to guess at your investments' long-term return. Instead, they rely on what's known as Monte Carlo analysis, which runs thousands of investment simulations based on past market performance. The aim isn't a down-to-the-dollar projection of your nest egg in 20 years, but to find the probability that you'll have the income you want. Most planners say a plan is on track if Monte Carlo analysis gives you an 80 or 90 percent chance of maintaining the income you want for as long as you expect to live.

But, to paraphrase the old military adage, no retirement plan survives contact with market reality. To stay on track, you must monitor your plan regularly and adjust to any curveballs the markets throw by saving more or working longer or recalibrating your desired retirement income. (See mext question for more on that.) One thing you can count on: The markets will throw curves.

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