From the April 2010 issue of Boomer Market Advisor • Subscribe!

The power and perversity of reduced retirement expectations

Most economists believe that the U.S. economy is recovering from the Great Recession. But it's clear that investors maintain a low expectation for our economy. In an important way these low expectations are a positive for financial advisors, especially those who know how to respond.

First, it's important for advisors to understand the surprising impact of low expectations. It appears to be common sense that people are more inclined to invest more if they expect large market gains. But there is ample evidence that, somewhat perversely, the reverse is true: when people expect big returns, they invest less.

Let's look at the last half century of savings behavior. During the decade of the 1960s, the average annual total return of the S&P 500, including dividends, was 7.8 percent. During that decade the savings rate averaged about 8.3 percent a year. In the 1970s, the total return of the S&P 500 decreased to 5.8 percent. Of course, savings rates increased to more than 9.5 percent. The years 1981 and 1982 were not good for the market, and there was some forward momentum for savings rates as it recovered. I guess people were not that confident in the market, after two sub-par decades. From 1980 to1984 that savings rate averaged 10 percent. Then it became clear; the bull market was real. The total return of the S&P 500 increased 17.3 percent on average during the entirety of the 1980s, and the savings rates started its slow and consistent decline: averaging 7.2 percent from 1985 to 1989. The average annual increase of the S&P 500 was 18.1 percent during the 1990s. That clearly encouraged the reduction of the savings rate. It was 6.4 percent from 1990 to 1994, 4.6 percent from 1995 to 1999 and 3.2 percent from 2000 to 2004. In 2007 the savings rate was an anemic 1.7 percent. I call your attention to the gradual nature of the decline. But then notice the rapid increase in response to the economic turmoil. In 2009, the savings rate increased to 4.6 percent.

Part of the reason for the increase in savings rates is clearly that people are trying to build up accumulations lost in the Great Recession. But the other part is that they no longer think the market will do it for them. Positive expectations of the market have declined significantly and that leads to more savings.

This is an important cue for advisors. Now, there is a perceptible "new frugality." This does not mean a renunciation of affluent lifestyles. But it does mean a commitment to spend more carefully.

There is another implication of reduced expectations. Not only are clients doing more to accumulate, they want you to demonstrate that you are doing more for them as well. Expectations by Americans of lower growth are not evenly applied to all economies. It appears that many investors expect less from the U.S. economy than they expect in other countries. Consider two surveys conducted by the Pew Research Center. In February 2008, 41 percent of Americans said the U.S. is the world's top economic power, and only 30 percent said China. The survey was repeated in November 2009 and the numbers reversed: 44 percent said China was the world's top economic power and only 27 percent say it is the U.S. This is an indication of not only perceptions of China's strength, but of their assessment of our problems. Thus, another impact of the Great Recession is that many Americans believe there are greater investment opportunities overseas than there are here.

Mathew Greenwald is president of Washington, D.C.-based Mathew Greenwald and Associates.

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