4 minute read
This is the eighth entry in our ongoing series, "Is Our Industry Prepared for Retirees’ Longer Lifespan?"
As retirements stretch into decades, the traditional rules of retirement planning are coming under stress.
In this post, we introduce a critical concept of The Retirement Real Return Rule, a new way to assess sustainability in retirement portfolios.
This principle challenges conventional thinking by focusing not on nominal returns, but on the spread above inflation that truly determines long-term financial survival.
The Retirement Real Return Rule
As we tinkered with the Target Sustainability Rate, we discovered what we call the Retirement Real Return Rule. This rule provides the minimum returns above inflation needed to sustain the modern retiree.
Our analysis - as shown in the hypothetical scenario below - reveals what we view as a fundamental truth that challenges the core assumptions of retirement planning. The critical component in retirement sustainability is not achieving a specific nominal return but rather maintaining a mathematical spread above inflation. This changes how we approach retirement planning in an era of increased longevity coupled with inflation.
If you examine our search for the Target Sustainability Rate, we have identified that maintaining a 4%-5% spread above inflation represents the minimum threshold for long-term portfolio sustainability.
This mathematical relationship explains why portfolios that appear adequately conservative by traditional standards may systematically fail over extended time horizons.
- At 1% inflation, a 6% net return would thrive (5% spread)
- At 2% inflation, a 6% net return would barely sustain (4% spread)
- At 3% inflation, a 6% net return would fail (3% spread)
- At 4% inflation, a 6% net return would collapse (2% spread)
Figure 1: Dunham & Associates Investment Counsel, Inc., 2025 (for illustrative purposes only)
This leads us to propose the Retirement Real Return Rule.
For sustainable 40+ year retirements, we believe that portfolio returns must exceed inflation by approximately 4-5%. This rule provides a dynamic framework that adapts to varying economic environments.
- 1% inflation environment requires ~5-6% returns.
- 2% inflation environment requires ~6-7% returns.
- 3% inflation environment requires ~7-8% returns.
- 4% inflation environment requires ~8-9% returns.
The implications are interesting.
At the Federal Reserve's 2% inflation target, retirees would require minimum net returns of 6-7%, which is significantly higher than traditional conservative allocations typically provide. This suggests that conventional "conservative" retirement strategies may be systematically undermining retirees' long-term financial security.
The Retirement Real Return Rule represents more than an incremental advancement in retirement planning theory. We believe it requires a fundamental reimagining of what we have been taught constitutes prudent retirement planning. In an era where retirements may span up to four or five decades, the industry must shift from focusing on nominal returns to maintaining critical spreads above inflation. The mathematics of long-term portfolio sustainability demands this.
This paradigm shift challenges financial advisors to reconsider their basic risk, return, and portfolio construction assumptions. Being too conservative in retirement may represent the greatest threat to long-term financial security. When you first hear this, it is an uncomfortable insight, but one that the financial community needs to examine.
Interestingly, each extra 1% of withdrawals from a retirement account adds an additional 1% to the spread over inflation.
The future of retirement planning does not lie in achieving arbitrary return targets but in maintaining the mathematical relationships that drive long-term sustainability. The Retirement Real Return Rule provides the framework for this essential change in modern retirement planning.
Next Up: Applying the Rule to Real Client Scenarios
In next week's Part 2 of this section, we will put the Retirement Real Return Rule to the test across multiple withdrawal rates and inflation environments - from 3% to 5% withdrawals and inflation levels up to 3%.
We will show you what the math reveal about portfolio sustainability in each scenario, and what hidden risks do today’s "conservative" portfolios pose for long-lived retirees.
The answers may surprise you.
Disclosures:
This communication is general in nature and provided for educational and informational purposes only. It should not be considered or relied upon as legal, tax or investment advice or an investment recommendation, or as a substitute for legal or tax counsel. Any examples are hypothetical and are for illustrative purposes only.
Information contained in the materials included is believed to be from reliable sources, but no representations or guarantees are made as to the accuracy or completeness of information.
Dunham & Associates Investment Counsel, Inc. is a Registered Investment Adviser and Broker/Dealer. Member FINRA / SIPC. Advisory services and securities offered through Dunham & Associates Investment Counsel, Inc.