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- It's impossible to predict what the future will bring, but a good financial plan should do its best to ensure you're financially prepared for whatever that may be.
- As a financial planner, I think it's important to consider how historically low interest rates could affect expected returns on fixed-income securities, like bonds.
- It's also important to consider how Social Security may — or may not — fit into your financial future based on policy.
- Use Blooom to analyze your 401(k) today and see how you can grow your retirement savings »
We've all heard the saying that the only constant in life is change. However true that may be, there's still value in doing your best to create a solid plan for your future.
Of course, that gets much more complicated when building a financial plan that forecasts what your life and finances may look like 10, 20, or even 30 years into the future — especially as unprecedented events like the coronavirus pandemic unfold during that time.
Some impacts from the pandemic are temporary, like the elimination of the 10% early withdrawal penalty on retirement funds. But COVID-19 will also likely have long-lasting effects on financial markets and the economy, for which your financial plan needs to account.
Here's what I suggest being mindful of as you work on your plan in a post-pandemic world.
There have been widespread debates within the financial planning community about what's reasonable when it comes to assuming the rate of return you'll earn on your investments in fixed-income securities, like bonds. Before the last major financial crisis (the Great Recession of 2008), most advisors used fixed-income return assumptions between 3% and 5%.
But when the Federal Reserve lowered interest rates to 0% in 2008, many advisors felt they could no longer be so sure about those assumed future returns. There were questions about how that kind of monetary policy would influence rates not just in the next few years, but in 20 or 30 years — when advisors' clients might be looking to retire.
Some advisors, like myself, kept with the 3% to 5% assumption. Others preferred to build plans to mirror what the economy looked like at the time, and lowered the rate of return they assumed their clients would earn to 2% to 3%.
I believe using current rates, rather than historical long-term averages, forces you to chase a moving target. I also think the return rate one should focus on within their financial plan should be the real, after-inflation rate of return.
Here's why: Let's assume that before 2008, your financial plan assumed you earned a 5% rate of return on fixed investments. It also assumed inflation of 4%. That plan, therefore, yielded an inflation-adjusted return rate of 1%. It projected the purchasing power of your assets grew just 1% per year.
In contrast, let's assume you use a lower assumption for your fixed rate of return of 2.5% and the most recent inflation rate of 1.37%. This would yield an inflation-adjusted return rate of 1.13%.
I don't believe we should follow trends. Instead, I believe projections should be built using historical averages. The pandemic has changed the way we look at both fixed-income investments and inflation, but remember that your plan takes the long-term view.
As rough as 2020 has been, it could be just a very small dip when considered 40 years into the future.
Before the pandemic, the Social Security Board of Trustees stated in its annual report that it projected trust funds to be fully depleted in 2034.
Now, thanks to financial relief policies such as the CARES Act and the executive order signed by President Trump in August, that timeline could accelerate.
Payroll taxes make up a considerable portion (approximately 90%) of the Social Security program's funding. While relief measures may alleviate pressure on Americans, they may also temporarily reduce the funding mechanism for Social Security benefits
One of President Trump's re-election promises is to eliminate payroll taxes permanently, which would move this from a temporary problem to a constant one. Some pundits say this would exhaust the trust fund much faster, as early as 2023. (The Trump administration believes that it can redirect other government funds to support Social Security, but that will require Congress' approval.)
So how should you adjust your plan based on these changes that took place as a result of the coronavirus pandemic? The answer depends on how conservative or aggressive you would like to be within your financial plan.
More conservative plans should probably exclude any income from Social Security; in other words, assume you won't receive anything. More aggressive plans might assume you'll still receive your full retirement benefit.
Keep in mind that Social Security benefits currently make up about 33% of the retirement income of people over 65. If you're going to plan conservatively and assume you'll get no Social Security, you also need to make a plan for filling that retirement income void.
While all of this might sound dire, we've actually been here before — and found our way out of the tough situation.
In 1983, the Social Security trust fund was running annual deficits and was on the brink of collapse. On April 20, 1983, the Amendments to the Social Security Act was signed into law. Massive reforms helped bolster funding so the program did not run out of money with which to pay out benefits.
There's still hope that we can find our way through again — but in the meantime, planning ahead and potentially assuming the worst while keeping our fingers crossed for the best might be the best way to go.
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