The long term is getting longer
When my great-grandfather was born in Belarus around 1850, life expectancy in most of Europe was about 35 years. Almost 40% of all children died before their 5th birthday. It didn’t matter if you were rich or poor. Peter the Great, Tsar of Russia, had fourteen children of whom eleven died in infancy or childhood. By the time my father was born in 1920, life expectancy had crept up to about 48. Today, we expect people in the developed world to live well into their 70’s or early 80s. Several factors increase life expectancy even more. The top 20% of the population by income can expect to live eight years longer than the lowest 20%. Non-smokers live longer than smokers. The strongest factor leading to variance in life expectancy is education; the highly educated live on average as much as 10 years longer than the least educated.
As wealth managers, one of our jobs is to make sure that each of our clients has enough money to maintain a dignified and comfortable lifestyle, no matter how long they might live. Our clients, as you might expect are mostly wealthier than average, better educated than average and less likely to be smokers. We now understand that if our clients are a healthy couple in their mid-60’s, they will likely need money for between 25 and 35 years, as statistics indicate that one of the couple will more than likely live into her or his 90s. That’s a pretty long time horizon, and we know that nobody can predict, even remotely, what is going to happen over a span of decades. What we can do is make projections on a regular basis, and keep running numbers to make sure that we are on track. This is one of the reasons that we insist on annual client meetings. It makes us, and our clients, focus on the long term, take changes into consideration, and adjust our expectations and forecasts accordingly.
What are the main things that affect how much our clients will have to spend over their remaining lifespan? There are three main determinants:
- What investment returns can we expect over time? The difference between an annual return of 4% and one of 8% is huge, and the difference is magnified over time due to compounding. Absent withdrawals and taxes, $1 million growing at 4% per year for 20 years becomes $2.2 million. Growth of 8% changes that to $4.6 million, a considerable difference. When we project far into the future we use 4%, even though this is well below the compounded growth of about 7.5% that our clients have enjoyed over the past 25 years.
- How much will our clients need to spend? As you might expect, spending decreases with age. Many couples and individuals do a lot of travel in their 60s and 70s, but for most this tails off in their 80s. As well, many couples are actively supporting children (many assist in buying first homes) and grandchildren. This also tends to reduce for those over 80.
- How long will income be needed? The numbers I have cited above are averages, and of course, every individual and every couple is unique. When I conduct annual reviews, I always ask about health, not because I am nosy, but because it is so important in assessing how much money will be needed going forward. Heavy expenses for personal health care at the end of life are a wild-card that can throw otherwise well thought-out plans into disarray.
Prior to 2022, interest rates were very low for about 12 years. This made it hard to lock in guaranteed returns using bonds. Now we have higher rates, and for many older clients we are moving money from equities to bonds. We are giving up some possible future growth for lower risk to capital. However, we are fully aware that we cannot go too far with this. If we need to assure a flow of retirement income for twenty or thirty years, we are going to need some of the capital gains that only ownership of stocks can provide. As with everything we do, each account is considered individually, and asset allocations are dependent on each client’s particular circumstances. As the long run gets longer and longer, we need to keep paying attention.
An Ernest Opinion by Ernest Wong
Long Term Investing Podcast with Barry Schwartz