It’s a money question that has no definitive answer: “How much should I save for retirement?” An exact figure is so elusive because everybody’s financial situation is different. In the past, most investors blindly considered 1 million dollars to be the number to target. Unfortunately, $1,000,000 could be considered a starting point for some.

It’s not a universal number. But a basic target can be calculated based upon your individual needs. Put more simply…multiply your current gross pay by 80%. This is a reliable factor for retirement spending. It’s not necessarily perfect. Spending tends to go down in retirement, but not for everyone. There are those that are planning large retirement purchases and spending. But a comfortable retirement can be expected at this spending rate. Exhibit 1 below offers a specific example for a current income of $65,000/year.

Exhibit 1

Current annual income =              $65,000

Anticipated annual Spending =   $52,000 (Current Income x 80%)

Other sources of Income =           $20,000 (Pension, Social Security, Part-time work)

Needed from Investments =        $32,000 (Anticipated spending less other sources)

Retirement Goal =                         $800,000 (Needed from Investments x 25)

If you’re overwhelmed by how much money you should have before retiring, start with your expenses. Focus on the expenses you can control. Naturally, the less money you spend on an annual basis, the less money you’ll need to retire.

It’s not a matter of luck. Your expenses determine if you can truly afford retirement. Sure, we don’t know exactly how much we’ll spend on an annual basis in the future, but most of us can reduce several major expenses like housing, transportation, and food if we truly tried.

The above exhibit is a very simplistic example of how to start the planning process. There are other items, like health care, that need consideration. Most people never start this process, because there are so many variables to consider. A financial adviser can help you create a strategy for savings, as well as a distribution strategy after your working years. There are several factors to be considered on your way to an enjoyable retirement. Please contact us for a complimentary investment projection and distribution strategy.

Should stock investors worry about changes in interest rates?

Research shows that, like stock prices, changes in interest rates and bond prices are largely unpredictable. It follows that an investment strategy based upon attempting to exploit these sorts of changes isn’t likely to be a fruitful endeavor. Despite the unpredictable nature of interest rate changes, investors may still be curious about what might happen to stocks if interest rates go up.

Unlike bond prices, which tend to go down when yields go up, stock prices might rise or fall with changes in interest rates. For stocks, it can go either way because a stock’s price depends on both future cash flows to investors and the discount rate they apply to those expected cash flows. When interest rates rise, the discount rate may increase, which in turn could cause the price of the stock to fall. However, it is also possible that when interest rates change, expectations about future cash flows expected from holding a stock also change. So, if theory doesn’t tell us what the overall effect should be, the next question is what does the data say?

Recent research performed by Dimensional Fund Advisors helps provide insight into this question. The research examines the correlation between monthly US stock returns and changes in interest rates. Exhibit 1 shows that while there is a lot of noise in stock returns and no clear pattern, not much of that variation appears to be related to changes in the effective federal funds rate.

Exhibit 1.       Monthly US Stock Returns against Monthly Changes in Effective Federal Funds Rate, August 1954–December 2016

Monthly US stock returns are defined as the monthly return of the Fama/French Total US Market Index and are compared to contemporaneous monthly changes in the effective federal funds rate. Bond yield changes are obtained from the Federal Reserve Bank of St. Louis.

For example, in months when the federal funds rate rose, stock returns were as low as –15.56% and as high as 14.27%. In months when rates fell, returns ranged from –22.41% to 16.52%. Given that there are many other interest rates besides just the federal funds rate, Dai also examined longer-term interest rates and found similar results.

So to address our initial question: when rates go up, do stock prices go down? The answer is yes, but only about 40% of the time. In the remaining 60% of months, stock returns were positive. This split between positive and negative returns was about the same when examining all months, not just those in which rates went up. In other words, there is not a clear link between stock returns and interest rate changes.

Conclusion

There’s no evidence that investors can reliably predict changes in interest rates. Even with perfect knowledge of what will happen with future interest rate changes, this information provides little guidance about subsequent stock returns. Instead, staying invested and avoiding the temptation to make changes based on short-term predictions may increase the likelihood of consistently capturing what the stock market has to offer.

Source: Dimensional Fund Advisors LP