Living longer + lower investment returns = saving more. How big is the challenge?

Retirees who are drawing income from their savings face the twin challenges of living longer and lower investment returns than their predecessors. As a consequence, retirees today must save more to generate the same retirement income than retirees in the past. But how much more? One factor working in favour of today’s retirees is that the cost of investing has fallen: fund costs have declined as low-cost index funds and exchange traded funds have become more prevalent. To what extent does this compensate for the challenges faced by retires?

We compare the retirement situation in 1996 with 2016.


From US life tables a single, 65-year-old male, in 1990 had a life expectancy of 14.98 years. For a 65 year old male in 2020 the projected life expectancy is 17.02 years, a gain of 2.04 years in 30 years. Interpolating these values gives a longevity for a 65 year old in 1996 of 15.39 years, increasing to 16.75 years by 2016.

Market Data

While we have historic data for investment returns from 1996 onwards, we must estimate returns for the future. We use PWL expected returns that blends historic performance with expected returns using current asset valuations. The overall impact is that future returns are expected to be lower than historic returns for both stocks and bonds.

We choose an investment portfolio with a constant allocation of 50% stocks and 50% bonds as being typical of a retirement portfolio. The annualised return for the period 1996-2016 is 7.53% and a volatility of 6.20%. The average annualised inflation during the period was 1.87%. The PWL expected return in 2016 was 5.10% with a volatility of 6.20%

Fund Expenses

From US data on balanced funds during the period 1990-2011 we estimate that fund costs have declined by 0.0105% /year. Canada fund data for actively managed mutual funds suggest a total average cost of 2.14% in 2016, but historic data going back to 1996 in not available. Assuming Canadian funds followed the same trends as US funds, we estimate the average Canadian actively managed fund had a total cost of 2.35% in 1996.

In 1996, the market for low cost index funds and ETFs was barely getting started. Now they offer an attractive alternative to actively managed funds: PWL and other providers can offer index and ETF portfolios for an annual fee of 1.4% or less. We consider the impact on retirement income of using the low-cost index fund/ETF approach.

Our input data are summarized in the following table:

Factor 1996 2016 (Active Funds) 2016 (Index Funds/ETFs)
Longevity 14.98 years 16.75 years 16.75 years
Fund returns 7.53% 5.10% 5.10%
Fund Volatility 6.20% 6.20% 6.20%
Inflation 1.87% 1.80% 1.80%
Fund Expenses 2.35% 2.14% 1.40%

Source: PWL Capital unless otherwise specified

Using the 1996 data we simulate a portfolio of $1 million at age 65, which is depleted over the expected life time according to the ARVA spending rule, discussed here. ARVA has the property of depleting the portfolio to zero over the specified period, making comparisons easier. We calculate the median total real income over the retirement period and divide by the retirement period to arrive at an average annual real income.

The results are given below:

Retirement Date Average Annual Real Income
1996 $81,860
2016 (Active funds) $63,382
2016 (Index funds/ETFs) $67,531

Source: PWL Capital

The retiree in 2016 faces the prospect of a lower retirement income from the same initial savings due to increased longevity and lower expected returns, even accounting for the decline in fund fees. From the table above, the annual retirement income falls from $81,860 in 1996 to $63,382 in 2016. To maintain the same real annual income enjoyed in 1996, an investor would need to save 29% more. Investors who uses index funds/ETFS can improve matters by raising the average annual real income to $67,531, so they only have to save 21% more.

We focused on the example of a single male retiring at age 65. For females and couples, or for anyone who retired earlier, the retirement period would be longer and the differences from lower fund fees would be more pronounced.