Saturday, September 30, 2006

401(k) Default Regulations - Capital Market Assumptions

The Employee Benefit Security Administration of the Department of Labor used a simulation model to estimate the impact of the proposed 401(K) default investment regulations on retirement savings in the US. This work provides several capital market return asumption data points that plan sponsors could use as collateral support for their capital market assumptions or plan participants could use in forecasting retirement needs.

The model inputs were:
9.48% nominal average return on diversified equity (6.5% real returns)
5.8% nominal average bond return (3% real)
2.8% inflation rate
Equity standard deviation estimate was 18.44%

A 60% equity portfolio using these parameters would expect about an 8% return. This is around the mean actuarial assumed return for US defined benefit plans. One peer reviewer noted the equity return assumptions may be overstated over a 20 year horizon due to the current historically high P/E multiple and the absence of an explicit fee assumption. Individuals using these projections might to apply a 100-150 basis point haircut.

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