Then Marston addressed the implications of lower returns on spending, using a real return on equities of 4.9% (the S&P return over the last 20 years) and real bond returns of 1.5%, or 1% below the average since 1951. Even with a 3% spending rate, there is nearly a 50% chance that the $100 million portfolio will suffer losses over 20 years and a 10% chance it will fall to $44.8 million.
Not surprisingly, the results from a 5% spending rate are much worse. There is a 50% chance the portfolio will drop by 50% and a 20% chance it will drop by more than 80% to $19.6 million.
There Are No Saviors
Can alternatives help generate higher returns? The performance of hedge funds has deteriorated dramatically from their glory days in the 1990s. “There are not 10,000 George Soroses out there,” Marston told attendees.
A Cambridge Associates study found that for the 10 years ending June 2018, hedge funds in the top 5% earned 7.5% more than the median. But the odds of your most affluent clients accessing those funds is slim indeed, Marston argued.
Private equity is a different story. Marston noted it has outperformed other asset classes, but he acknowledged that the typical retiree with $5 million can’t afford the illiquidity. Moreover, valuations “are high, like everywhere else,” he noted. “If I were rich, I’d have a significant allocation to private equity.”
There are other complications, however. As with hedge funds, private equity performance dispersion is vast. Even wealthy families with hundreds of millions of dollars can’t access the same high-quality managers that the Yale endowment or the Swedish sovereign wealth fund can. Marston found that a portfolio with a 10% to 20% allocation to private equity (the exact figure would vary from year to year) over the last 20 years would enhance the return by an anemic 0.3%. The client or foundation might be able to increase the withdrawal rate from the 3% area toward 3.5%, but that’s “not a game-changer,” he said. It’s also important to remember that Marston examined withdrawal rates over a 20-year period; most advisors plan for a 30-year retirement.
Ten years into a bull market, many clients don’t realize that equity performance has been significantly lower for the last two decades than it was in the 20th century’s second half. One clue is that economic growth in both the U.S. and the rest of the world has declined over that period, Marston noted. In the last 17 years, GDP growth in the U.S. has averaged 1.8% annually. Despite a huge tax cut in 2018 and massive deficit spending, both of which were previously unheard of this late in the cycle, GDP growth “struggled to get to 3.0%” in 2018. Marston was speaking in mid-February, and the actual number came in at 2.9%. “That won’t last,” he predicted.
The low return-low growth problem isn’t confined to America. Marston cited Japan, where growth fell from 8% on average in the 1950s and 1960s to about 1% since 1991. France and Germany enjoyed 2% and 3% growth in the 1990s. Since 2001, eurozone growth has meandered around 1%.
An aging population and declining productivity—the latter is accelerated by an economy’s transition from manufacturing into service—are the two major drivers. Some of this was becoming apparent in the 1980s. Marston recalled the words of his former M.I.T. economics professor, Nobel laureate Robert Solow, who said at that time, “I see computers everywhere in America except in the productivity growth statistics.”