Confirming a 7.5% Return Assumption
Your client, age 47, holds $1.25M and contributes $30,000 at each year-end. Her goal is $3.5M at age 62 - a 15-year horizon - at which point she retires. She is 80/20 equity-heavy and rejects any projection below 7.5%, the return her previous adviser used in a plan she has already circulated to family. Your firm's current 15-year capital market assumptions are 7.2% nominal for global equity and 4.4% for investment-grade bonds, with 2.5% inflation. She has asked you to 'confirm the 7.5% so we can stop revisiting it.' Your investment committee also requires a written justification for whatever long-term assumption appears in any client plan.
1. What return does the plan actually require, and what does that do to the 7.5% assumption?
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Solve for the required return. The goal is the future value of $1.25M plus $30,000 of year-end contributions over 15 years:
- At 5.5%: $1.25M × 2.2324 = $2.79M; annuity factor 22.408 × $30,000 = $0.67M → $3.46M, short by ~$37k.
- At 6.0%: $1.25M × 2.4307 = $3.04M; 23.454 × $30,000 = $0.70M → $3.74M, a $242k surplus.
Interpolating, the required return is ~5.6% (5.6% produces $3.51M). The 7.5% assumption sits roughly 190bp above what the plan actually needs.
Why that matters more than the number itself. The assumption is not a forecast to defend; it determines the risk posture. At 7.5% the client can 'justify' 80/20. At the 6.1% the 60/40 CMA implies, the goal is still met with a $242k margin, and the contribution could fall to about $19,700 (= $461,600 / 23.454). The 7.5% is therefore not a planning input - it is a risk-appetite decision dressed up as arithmetic.
2. Can any portfolio earn 7.5% under your assumptions? What do you recommend?
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The maximum is 100% equity at 7.2%. The implied equity weight that delivers 7.5% is (7.5 − 4.4)/(7.2 − 4.4) = 111%, i.e. leverage. The client's current 80/20 is worth 4.4 + 0.8 × 2.8 = 6.64% nominal (4.04% real) - not 7.5%.
Four levers exist, and only four: save more, extend the horizon, lower the goal, or accept a lower return. Recommend accepting ~6.1–6.6% and de-risking to 60/40–70/30, because the goal requires ~5.6% and a 60/40 delivers 6.1% with a $242k cushion.
Do not present a point estimate as the plan. With 16% equity volatility, the standard error of a 15-year annualized return is roughly 16%/√15 ≈ 4.1%. A 6.1% mean implies a 15-year distribution of roughly ±8% at two standard deviations. The honest planning object is a distribution: show the 25th-percentile outcome and what it does to the goal. That is the argument that actually changes behaviour.
3. The client says 7.5% is 'just a planning number, not a promise.' What goes in the file?
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Distinguish three numbers that are currently blurred into one:
| Number | Value | Role |
|---|---|---|
| Required return | ~5.6% | The hurdle the plan must clear |
| Expected return | 6.1% (60/40) | What the portfolio is likely to earn |
| Hoped-for return | 7.5% | The client's preference |
The file should record: (1) the source and date of the CMA and its range, not only the point; (2) funded status at the expected return and at the 25th percentile; (3) the levers considered (contributions, horizon, goal) and why each was adopted or rejected; (4) an explicit statement that 7.5% is retained only as an aspirational scenario and is not the basis of the spending plan.
If she insists on 7.5% as the plan basis, that is a knowing deviation: document it, obtain written acknowledgment, and set a review trigger - for example a three-year rolling real return below 3%, or any change in contributions or retirement date. 'Not a promise' is precisely why it cannot be the basis of a plan.