The Best Way to Keep Your Retirement on Track - Even When the Market Stinks

Nearly 70% of more than 1,000 401(k) participants polled in a recent survey said they expected to be able to save enough to meet their financial goals in retirement. Problem is, those expectations may be based on overly optimistic assumptions about the rate of return their savings will earn.

Indeed, two-thirds of those who participated in BlackRock's latest DC Pulse Survey said they believe future gains will be in line with what they've seen in the past, and nearly 20% expect them to be higher. Which raises the question: Are you putting your retirement in jeopardy by being overly optimistic about the returns your retirement accounts are likely to generate?

There's no doubt the market's been on a roll in recent years. Since hitting bottom in the wake of the financial crisis eight years ago, stock prices have more than tripled, giving stock investors an annualized gain of almost 18% including dividends. And while bonds haven't performed as spectacularly, they've still managed a respectable average annual return of nearly 5% over the same period.

But given today's lofty stock valuations, low bond yields and modest prospects for economic growth, many, if not, most investment pros foresee more muted gains looking ahead. In its most recent quarterly outlook for investment returns, for example, asset manager BlackRock said it expects U.S. stocks to gain an annualized 5.9% over the next 10-plus years and bonds to return 3.1%. Fund giant Vanguard is slightly more optimistic about stocks in its 2017 outlook for the economy and the market with a median forecast of an annualized 6.6% over the next decade, but it is less sanguine about bonds, with projected gains of just 2.1%.

The upshot: You could very well be looking at returns that will not only trail those of recent years by a wide margin, but also fall well below the long-term historical averages of 10% a year for stocks and 5% for bonds over the past 90 or so years.

So what can you do to build a nest egg large enough to sustain you throughout retirement if the financial markets deliver significantly lower returns than in the past?

First, a Warning

Actually, let's start with what you shouldn't do, which is try to make up for below-average returns by investing more aggressively. While tilting your retirement portfolio dramatically toward stocks or loading up on volatile technology or small-cap growth stocks does have the potential to generate bigger gains, the volatility that comes with a higher-octane portfolio can also work against you and leave you worse off, especially if this aging bull market gives way to a bear market that can lop 50% or more off stock prices.

The same caution applies to bonds. Moving from short and intermediate-term bonds to long-term issues that carry higher yields may seem a sure-fire way to boost returns in a low-interest-rate environment. But if interest rates tick up—which seems likely given that the Federal Reserve has signaled continued "gradual increases in the federal funds rate"—bond prices will fall, and bonds with the longest maturities will generally get hit hardest.

Fortunately, there's a more effective approach to coping with anemic returns than throwing the dice and taking on more risk. Settle on a mix of stocks and bonds that makes sense given how much time you have before you retire and the level of volatility you're comfortable with—which you can do by going to a risk tolerance-asset allocation tool like the one Vanguard offers free online—and then invest as much as possible in funds with low annual costs.

By opting for low-cost index funds and ETFs, for example, you may be able to reduce the amount you shell out in annual investment fees by a half to a full percentage point, if not more. And while there's no guarantee that every dollar you save in costs will translate to an extra dollar of return compared with more expensive funds, Morningstar research shows that low-expense funds typically outperform their high-fee counterparts, which increases the likelihood that you'll get the most out of whatever size gains the market delivers.

You Know We're Going to Say This, Right?

As a practical matter, though, there's no way around the fact that building an adequate nest egg in an era of lower returns will also require you to save more. That's a matter of simple arithmetic. For example, if you stash $1,000 into a retirement account each month and earn an 8% annual return, you'll have roughly $181,000 after 10 years. If your return is 6% a year, your balance would slip to about $163,000. To end up with the same $181,000 with the lower 6% return, you'd have to save an additional $110 a month.

It's difficult, if not impossible, to pinpoint exactly how much extra you might need to save to stay on track if returns come in well below past levels. The amount can depend on, among other things, how much you've already saved, how you invest your savings, how many years you have until retirement and what sort of retirement lifestyle you envision. And even if you could gauge the necessary additional savings, there's the question of whether you can afford to devote more of your income to savings considering that you've also got a life to live and bills to pay before you reach retirement.

More from RealDealRetirement.com: A Smart-But-Simple Investing Strategy That Actually Works

That said, if you're already putting a reasonable percentage of your income into retirement accounts—say, 10% to 15%—throwing in an additional 2% to 3% of salary (or more if you can handle it) can go a long way toward countering the effect lower investment returns will have on the eventual size of your portfolio. If you can't manage such an increase all at once, you can always bump up your savings rate gradually—say, increasing it by a percentage point every year or so or saving half of any raises you receive.

Unfortunately, paring investment costs and pumping up your savings rate still may not be enough to compensate for lower returns. But that doesn't necessarily mean you're doomed to a grim retirement. There are additional steps you can take to boost the size of your portfolio or at the very least make it last longer, such as staying on the job longer to give your retirement accounts more time to grow and waiting a few years to claim Social Security to qualify for a larger benefit. And even after you retire, there are moves you can make to improve your prospects, such as working part-time, downsizing, taking out a reverse mortgage or even moving to an area with lower living costs.

Or you could just hope that the forecasts of more subdued returns in the future are overwrought or flat out wrong. But if it turns out that you're the one who's mistaken, you may find yourself with no choice but to make some radical and unpalatable adjustments to salvage your retirement.

Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com. You can tweet Walter at @RealDealRetire.