Future retirees looking to live off retirement account withdrawals need to feel confident they have enough money to sustain those withdrawals for their remaining lifetime. This means estimating how much money you’ll have when it’s time to retire might be the biggest single step in planning for retirement.
There are several factors that go into estimating the future growth of a retirement account. Those factors include the number of years the retirement account will be growing before retirement, the amounts that will be added to the retirement account, and the return on investments in the retirement account.
In this post, we’ll consider:
- Each of the 3 factors above that affects the growth of retirement accounts from a calculation perspective
- A dangerous mistake many investors make when estimating the future growth of retirement accounts
- What drives the growth of your retirement account the most (I think you’ll be surprised!)
- What you can and cannot control regarding the growth of your retirement account
- 5 specific tips for estimating the future value of your retirement account
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The Number of Years The Retirement Account Will Be Growing
The number of years until retirement is, fortunately, one of the factors that is usually under the control of the retiree.
Of course, sometimes companies retire employees before their desired retirement date, but additional years of employment can usually be secured elsewhere. Alternatively, individuals can pursue one of the many potential income streams and continue adding to a retirement account via a solo 401K if desired.
Many retirees plan to retire at a specific age, then decide to retire later after catching up retirement savings. This is often based on a fear of outliving retirement savings when the amount saved is less than they had earlier estimated it would be.
Of course, sometimes the opposite happens. Retirement dates are moved forward rather than backward. This is most common following stock market increases and economic growth that supports employment and employee bonuses, as addressed later in this post.
Amounts Added to the Retirement Account
The growth of a retirement account can be significantly improved with regular additions to the account. This, too, is a factor that is largely under an investor’s control, although it can sometimes feel like it’s not when expenses keep rising.
The fact is that systematic savings help fuel retirement account growth.
Return on the Investments in The Retirement Account
Here’s where estimating the future growth of a retirement account gets very tricky. The return on the investments in a retirement account is impossible to know for sure, and that’s outright unnerving when estimating how much your retirement account will grow in the future.
Now that we’ve looked at the 3 major factors affecting the growth of retirement accounts, let’s look at the most common measures used to estimate future returns.
How Future Retirement Account Growth Is Estimated
Most investors own some form of stocks in their retirement account so let’s start there.
Investors commonly use the historical long term return for the same type of investments held inside the account to estimate the future growth of that retirement account. An index is frequently used.
For example, many investors own some type of S&P 500 index fund inside their retirement account. The most common practice for estimating the future growth of the stock portion in a retirement account is to simply use the long term historical average return for the S&P 500 and project that past average return into the future.
The long term average annual return for the S&P 500 index is 9.87 from January 22, 1993, through April 30, 2023, to put this in perspective.
Of course, not all investors own stock indexes in their retirement accounts; instead, they own a portfolio of individual stocks. How can investors that own a variety of stocks estimate the future growth of their retirement accounts?
In this case, the long term past returns for an index most similar to the retirement account holdings is used to estimate future growth.
The S&P 500 index, for example, is commonly used to represent a portfolio of established large company stocks in the US that are diversified among industries. The S&P 500 often aligns with a portfolio consisting of individual stocks unless the investor is heavily weighted in a specific area, such as small company stocks, or tech stocks, for example. In that case, another index closer to the holdings in the retirement account is used to estimate future growth.
Most traditional portfolios also hold bonds in index based funds in addition to stocks. Similar to stocks, long term average returns of the bond index fund are commonly used to estimate the future growth of the bond portion of a retirement account.
Using Past Performance to Estimate Future Growth of Retirement Accounts
This common method leads astute investors to ask the question: is it reliable to use past performance data to estimate the future growth of a retirement account?
We’ve all heard the dire warnings that “past returns are no guarantee of future returns”.
On the one hand, when it comes to retirement planning, all we can do is estimate the future value of our retirement account based on historical index data since we can’t know what the future return will be. This is true unless some type of product with a guaranteed return is held in the account, such as an annuity.
On the other hand, using a long term average can be inaccurate when estimating the future value of a retirement account, and here’s why.
The often overlooked reality is this: We don’t get retirement account growth based on the past long term average return when we invest. Instead, we get the growth that happens as a result of the returns that occur during the time we’re holding our investments.
The fact is that expected retirement account growth can even turn out to be a loss instead of growth!
Historical data reveals the importance of this reality. For example, the S&P 500 had an annualized average negative return of .92% (including dividends) for the 2000’s decade.
Just imagine if someone retired in 1999 planning for their retirement account growth to be the long term average return of almost 10% in their first 10 years of retirement, and it turned out the be negative.
Similarly, a stock investor planning to retire in 2010 would have been very disappointed that his portfolio had not grown as expected.
Therefore, basing the future value of your retirement account on past returns from a different time frame can seem almost careless.
The rest of this post will be on ways to improve your ability to estimate the future growth of your retirement account.
Tips for Estimating Future Retirement Account Growth
You can certainly use past long term returns for benchmark indexes as explained above; this is common, but it’s not what I do myself or with my financial coaching clients.
Here are 5 tips for estimating the future growth of your retirement account that might help lessen the likelihood of being way off in your estimate.
Consider the following.
- How your investment strategy is likely to perform during different economic situations
- The most likely economic scenarios during the years you’re estimating the growth of your retirement account
- The current economic environment, and what’s most likely to follow in the years ahead
- Having a Plan B for if you’re completely wrong in estimating the future value of your retirement account
- Being conservative in your estimate for the future growth of your retirement account
This may sound daunting, but it’s all very doable, and essentially free other than your time as explained in my investing course.
Resources to Improve Your Ability to Estimate Future Growth
Educate yourself about economic and market cycles so you’re not caught off guard when they change, as they certainly will. Approach the topic as fascinating instead of overwhelming; it’s super important to your financial wellbeing.
Check out my list of advanced investing books to see my own progression to becoming more knowledgeable about investing. You’ll enjoy my post with advanced investing YouTube channels if you prefer videos.
You could also consider using or consulting with a tactical financial advisor (vs a financial advisor that buys and holds the same assets based on a fixed type of asset allocation regardless of economic cycles). Even if you decide to use a financial advisor, I recommend consuming some of the advanced investing podcasts, books, or videos so you’re confident in hiring and working with a financial advisor.
How I Estimate the Future Value of Investment Accounts
I personally estimate the future growth of my retirement accounts using a slightly more advanced technique than simply using a long term average return for an index projected forward. Here is my process.
First, I use the 5 tips above. Then I check the long historical return data for the particular investment strategy that I’m replicating in my portfolio.
I do this with the tactical asset allocation strategies I use to invest as explained in my Allocate Smartly review.
The data time frame I use for my future growth estimate must include periods during which economic cycles are varied so I can see how an investment strategy performed during different macroeconomic (big picture) situations or I won’t use the strategy to invest in the first place.
For example, ideally, I like to see 50 years’ worth of return data since the 1970s presented economic factors quite different from those in the subsequent four decades. This helps me avoid a common mistake investors make, the assumption that what has happened lately will keep happening, known as recency bias.
And, of course, that 50 year time frame included several bull and bear markets providing valuable insights, like most 50 year time frames. I love knowing there is a variety of types of stock markets in my return analysis.
From this data, I look at returns for each year, not a long term average when doing this process. This allows me to consider what was happening at the time and how it correlates to the return for that year.
I want to see the long term performance data because the fact is that different economic situations occur. And these economic factors will determine the growth of my retirement account, not a long term average return that occurred during a different time frame with different economic factors.
When we are aware of this fact, we can be better prepared and probably even improve the growth of our retirement accounts.
Factors That Affect Retirement Account Growth
There are the three factors addressed earlier that affect the calculation for the future growth of retirement accounts. One of those three factors is investment return.
There are macro factors that affect the return you’ll get. They include:
- Bear markets
- Recessions
- High interest rates
- Low interest rates
- Bull markets
- Economic expansion
Very few experts precisely predict these events but when you consider the big picture, common sense can be a guide. Let’s look at a few simple examples of when it would be wise to consider one of these factors in the future growth of a retirement account.
How Interest Rates Affect Retirement Account Returns
We knew when interest rates were near zero, they couldn’t go much lower; it was mathematically impossible.
We could also easily observe a 40 year interest cycle which broadly declined from the 1980s all the way down to near zero in the late 2010s decade. It was logical to assume the interest rate decline had to end soon.
A core investing principle is that rising interest rates have a negative impact on stock and bond returns.
Therefore, combining this simple observation of the glaringly obvious long term interest rate cycle with this core investing principle could help avoid expecting too much growth in your retirement account in the years following such a cycle.
This is just one example of a few big picture factors that affect investment growth in a very large way. Let’s look at another such example.
Estimating Stock Market Returns
We can recall that the majority of the time the S&P 500 experienced that 9.87% average annualized return noted above:
- Interest rates were declining
- The Federal Reserve’s actions (indirectly) accommodated a rising stock market
These economic factors provided the fuel for good stock market returns.
These observations work both ways and can support a reasonable expectation of higher future growth for the stock portion of your retirement account. For example, remembering back to March of 2009, after stocks had been through a devastating and lengthy bear market, it was reasonable to expect a higher future growth for the stock portion of your retirement account.
Estimating Growth of Bonds in Retirement Accounts
I mention these two examples because they are timely.
Different, and equally important factors affect the performance of bonds and other defensive investments many investors own, however.
For example, unusually high interest rates suggest rates will need to decrease soon. Another core investing principle is that when interest rates decline, the price of most bonds increases. Therefore, it’s logical to estimate for higher future growth in a retirement account that owns bonds when interest rates are set to decline.
Summary for Retirement Account Growth Estimate
A very common mistake investors make when estimating the future growth future of retirement accounts is overlooking these important economic factors which strongly affect the growth of retirement accounts.
We can improve our ability to estimate the future value of our retirement accounts when we estimate with consideration of various economic situations, however.
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