Reply to What growth rate to use in retirement planning?

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[quote=Anonymous][quote=Anonymous]My financial advisor used 6%, ... . I am currently in [b]60% equity[/b][/quote]

You have an honest advisor.  Most of them use conservative assumptions to make you save more and generate higher fees.

Use real (after inflation) returns.   The real risk-free rate is around 1%.  You might use a 6% equity premium over the risk-free rate.  Since you are only 60% in equities, that would give you 3.6% return premium, for a 4.6% total average return.  However, the expected compound return (growth rate) is less than the average return by half the variance of return.  The volatility of the market is around 15%, so you need to subtract off around half of (.6*.15)^2, or almost half a percent.  So your expected growth rate would be around 4%.

But I believe in using Certainty Equivalent, not growth rate.  In that case, you roughly cut your return premium in half.  Intuitively, the first dollar in the market has negligible risk, but the risk of the last dollar completely offsets its return because you refuse to invest more.  Therefore the risk-adjusted benefit is only half the expected return premium.  In your case, the real Certainty Equivalent return is about 1% plus half off 3.6% or 2.8%.

If you raise your assumption to an 8% equity premium, then your real Certainty Equivalent return is 1% + .6*8%/2  =  3.4%.  You are rather cautious and would have higher expected results if you were comfortable investing more aggressively.[/quote]

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