The assumed rate of return on an investment is an important consideration, especially since assuming a rate of return that is too high might cause the individual to under-invest.
You should understand the difference between an assumed rate of return that is optimal and one that is going to give you the highest probability of reaching your goals.
In a perfect world, your portfolio would average 15-20% per year, forever, but this is really not feasible.
Investors who got into the market after 2008 and experienced a very bullish couple of years, might have assumed that such performance should be expected all the time. Unfortunately, that is not up to us, or our advisors.
The market as a whole is going to set the pace on your earning potential year to year, and over time it is likely to show “regression toward the mean,” that is, up years and down years will be corrections and retracements that hover around a longer-term average.
You might have experienced a bullish 7 years, for instance, but investors and advisors that have been in the market for 30 years or so have learned to be humble enough to accept very modest returns in years which are not as bullish, or even bearish.
Long-term return is generally closer to 8% rather than 16%, and being conservative with assumptions can only make you wealthier. If an investor assumes that their portfolio will earn 10%, since that is what it appears the S&P 500 earned over the last time frame the investor is looking at, the investor may calculate that he or she would only have to invest a small amount to reach their goals.
If the return is more modest than that, the investor may discover one day that it will be extremely hard to reach their previous retirement goal, because, after being underinvested, they no longer have the opportunity for as many years of compounding interest.
They may need to invest another $3000 a month to reach their goals instead of another $300 as they should have done from the beginning with more conservative assumptions. That additional $3000 a month may not be feasible for them, and they might end up needing to work part-time in retirement, like so many other retirees.
Many planners use an assumed return as low as 6% to increase the likelihood that the plan will work out the way it is designed. Then, if the portfolio does achieve a long-term average rate of return over 10% or 15%, the person has the option to retire earlier than planned, or travel more, or give away money to their children or charity.
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