August 3, 2020

What’s a realistic return expectation?

The market is unpredictable, that much is obvious. The Dow Jones literally fell over 50% during the housing crisis but then rebounded with returns near 40% the year after. Regardless of what the market does from one year or even one decade to the next, the overall trend has always been up. That’s not a prediction or educated guess, it’s a fact from over 100 years of data. But when I hear people mention that they’re going to make 20% in one year it makes me cringe because their logic is either nonexistent or wildly misguided.
So what’s a conservative (and approximate) return for a portfolio comprised entirely of stocks? About 6%. High return? 15%. Average return? 10%.
But should I expect my returns at the end of 2017 to be 10% on the dot? Hell no. It’ll more likely be 20% one year and 0% the next.
Inflation, or the rise in cost of goods, must also be factored in. With average inflation rates at 2-3%, you need to subtract this from all the numbers above. That’s why I use 7-8% returns in my estimations. It’s roughly average (10%) and factors in inflation (2-3%). Remember however all these numbers have been the average over the long run (we’re talking 20+ years). They can vary wildly, as I mentioned from year to year.
Bonds are much less volatile (meaning they are more stable and predictable) but produce lower returns than stocks. Less risk, less reward. Bonds are simply debt (for someone else). The returns you get from them is the principal from the debt payment plus a bit of interest. With national interest rates currently near rock bottom the rates of return are low right now, so think 2-3% max. But of course this can change too. The Fed has even said within the past few weeks that they plan to raise rates roughly 3 times this year, likely starting in March. In the 70’s, in order to curb inflation interest rates hit nearly 15%. Generally though, investors use bonds to lower their portfolio risk but in turn lower their overall return by a few percent (this depends on how much money is allocated to stocks vs bonds; more on this another time).
All that is a lot of mumbo jumbo to get at the point that a decent estimate is about 7-8% per year. Take anything else you hear with a grain of salt, because it’s probably either wrong or simply way out of context.

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