Managing Expectations: What Will Your Portfolio Deliver?
Financial Advisors Say to Expect 6-8% Rate of Return (above inflation)
What rate of return are you expecting to get from your diversified portfolio? A new survey of financial professionals was just taken, and on average, financial professionals expect to earn 7% above inflation over long periods of time. That number is largely unchanged from other surveys that have been done over the past quarter century. Financial advisors are pretty consistent in saying that returns ought to be in the 6% or 7% or 8% rate above inflation. But when individual investors were asked that question, their average answer was not 7% per year, but 17 ½ % return per year. Really?
We should recognize that your investment results are going to be impacted by your investment expectation. In other words, if you are expecting seven, which is what advisors are expecting and you get 10, wow, this is a great year. But if you're expecting 17 and you get 10, you'll be upset and disappointed. This may cause you to sell those wonderfully performing investments in a desperate effort to achieve a higher return that is impossible to get.
There's only one reason that investors say they're expecting 17% annual returns. Over the past several years prior to 2022, they were getting it. So if you're a relatively new investor since 2018, yes, a 17% return is understandable because that's what the financial markets were delivering. That is incredibly unusual.
Since 1926, the S&P 500 has averaged about 10% per year, over a hundred years. Sure, there'll be some up years of 18 or 20 percent, but there'll also be some down years of 18 or 20 percent. To expect that you're going to earn 17 ½ percent over many years is unrealistic.
If you're building a financial plan based on that assumption, you're going to invest less because the return will be so high you don't need to bother investing more. That plan is doomed to fail. You'll discover, though, in the future you're not going to accumulate the wealth that you think you're accumulating because you're not getting the return that you're hoping to get.
Make sure you have realistic expectations about your returns if you want to have any hope at all of achieving them. Otherwise, your future will be a lot more frustrating and disappointing than you're hoping for. And here's a related problem that investors are making.
Let me frame it for you this way: You're busy saving and investing money. You're letting that money grow in value and in retirement. When you're no longer earning a paycheck, you're going to start to use the money that you've saved all your life. That's why you're saving it. So you'll have it available to you in retirement. So when you're in retirement, what are you going to spend? Are you going to spend only the income and interest, only the growth and the dividends? Are you never going to touch the principal? 75% say they will never touch the principal. If they've got $1 million in the account, they'll withdraw the interest and the dividends. But they will never touch the principal. They'll leave the million dollars alone. If they've got $1 million at age 65, they're going to die in their 90s with the same million dollars intact. They never touch principal. I think it's the 11th commandment: Thou shalt not touch principal. If you think you're never going to touch the principal, you're probably crazy.
It is extraordinarily unlikely that you will be able to live on the dividends and interest alone unless you’ve got an extra few million saved. Odds are far higher that you will invade principal, that you will withdraw money from the account beyond its interest in dividends and growth.
You need to recognize that fact and know - it's okay to do. There's no problem with withdrawing principal. We just want to make sure you don't withdraw so much principal so fast that you end up going broke. That's easy to avoid with proper financial advice. Be sure that you have realistic expectations about how much you're going to earn while you're saving and how much you're going to withdraw while you're in retirement.