By Ethan Haskel (TMF Cormend)
May 10, 2000

There's one number in your life that can subtract up to two decades from your age -- your retirement age, that is. This figure can mean the difference between waking up on your 60th birthday and charging out the door headlong into rush-hour traffic or leisurely sipping French roast with your morning paper. Just one silly little number can determine if that same birthday is filled with harried office phone calls or a leisurely stroll through the woods.

What single number can have such a profound effect on your life? It's the average annual return on your investments. Arguably more than any other number, your lifetime investment return will determine when you can retire. Literally millions of dollars may be at stake.

You can see the dramatic effect of your average investment return by playing with a retirement calculator. Such a calculator collects data like your age, existing assets, income, and living expenses to estimate your future assets. When your assets reach the point where they are sufficient to spin off an income that lets you live comfortably for the rest of your life without employment income, you're ready to retire.

Our Foolish retirement calculator lets you see if you're on track to retire at a particular age. You can also run different scenarios to experiment with changing the various assumptions. I was particularly interested in examining how a particular investment return rate can affect one's retirement age. You can check this out by clicking on "What if I overestimate my return?" at the bottom of the calculator.

The effect of such differences in investment returns are dramatic. Using most scenarios, a difference of a few percentage points in annual returns can change your retirement age by many years. For instance, earning a return of two percentage points a year more than the calculator's default rate will let you retire 12 years earlier than if you underperformed the default number by two percentage points.

The observation that relatively small differences in annual returns can dramatically affect your retirement age also underscores the importance of keeping an eye on your investment expenses. For instance, a "mere" 1% annual expense fee can delay retirement by three years.

When we plan for our future retirement, just what annual return number should we use in these calculators? Should we use a 7% return, a number that I often see many financial advisors recommend? Or should we plug in 11%, the historical long-term return of U.S. stocks? Maybe we should enter 19%, the annual return of the S&P 500 over the past decade?

Can we Fools do even better? Maybe we should plug in 20%, the average return for the Foolish Four since 1961? Or why not plan for returns averaging 30% a year, the backtested returns for a number of Workshop screens? The Rule Breaker portfolio has averaged a 57% return since its inception in 1994. Is that a good Foolish number to use?

On the darker side, maybe a paltry 2% return would be more realistic, given the predictions by some esteemed economists that the Dow will pretty much tread water for the next 20 years. (See Irrational Exuberance, by Yale Professor Robert Shiller, for the gory details.)

It's pretty clear that these numbers are all over the map. But does that mean we should throw up our hands in frustration, forgo any planning whatsoever, and leave our future up to the fates to decide? That would be very UN-Foolish.

Next week, I'll try to give a rational explanation of what number we might plug into these retirement calculators. We'll also discuss the pitfalls of such planning. In the meantime, take some time to run a few scenarios of your own. You'll soon see how one silly little number can make your future mornings a whole lot nicer.

Beating the S&Pyear-to-date returns
(as of 05-09-00):

Bank One <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ONE)") else Response.Write("(NYSE: ONE)") end if %>           -5.7%
PepsiCo <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PEP)") else Response.Write("(NYSE: PEP)") end if %>            +7.3%
Ford Motor Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %>       +1.4%
Bank of America <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BAC)") else Response.Write("(NYSE: BAC)") end if %>    -3.0%
Fannie Mae <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FNM)") else Response.Write("(NYSE: FNM)") end if %>         -8.3%
Beating the S&P                -1.7%
Standard & Poor's 500 Index    -3.9%

Compound Annual Growth Rate from 1-2-87:
Beating the S&P               +23.4%
S&P 500                       +17.1%

$10,000 invested on 1-2-87 now equals:
Beating the S&P            $165,000
S&P 500                     $82,200