Thursday, August 20, 2009

Back to The Blog

Well, we're back from some time-off, ready to take on the world. We have actually been back for several days, which was mainly spent going through e-mails, voice mails, snail mail, ...

We had a lot of fun with our kids this summer, but I, for one, won't shed a tear when the school bus returns in two weeks. (I actually tell the kids that the first day of school is like Christmas for parents-- we dance and sing songs.)

I had a great suggestion from one of our clients concerning our last blog post. He said "It would be neat if the market stats and your resulting commentary were also correlated somehow to getting back on track with respect to retirement goals. That would make it all personally meaningful."

My primary goal with this blog is to make connections between the broader economy and the personal financial goals of our clients and other readers, so this suggestion is exactly what we are looking for.

Starting last November, when the stock market hit the first lows of the "financial crisis", we began to increase the rate of return assumption in our clients' financial plans. Now this may have seemed counter-intuititive to some at the time, especially in the midst of all the uncertainty and nervous feelings about the future of our economy, but it makes sense when you analyze how markets have traditionally recovered from downturns in the past. We have generally built financial plans with an assumed rate of return of 5% over inflation (or real return). Last November, after analyzing how markets have behaved in the years following previous downturns, we increased that assumption to a 6% real rate of return.

Looking at the table from our last blog post, we see that stock markets have recovered in the neighborhood of 55% since the lows hit in March (these lows were very close to the November lows). If you were to assume a 6% real rate of return over twenty years, every $100 invested would become $320 at the end of that time period. If, in the first year, the return is 55%, then you only need 3.8% return over the next 19 years to get to the same $320.

What this means is that we are now returning to a 5% real rate of return assumption in our financial plans. For our clients, this means that we have likely avoided the worst case scenarios that were put forth last fall, and their financial plans have likely survived without the need for drastic measures.

I am not saying that everything will be rosy going forward, but we are much more comfortable returning to a 5% real rate of return assumption for our financial plans. This is a relatively conservative assumption which is well below the average return over the past half century.