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November 11, 2021
Predicting your rate of return is impossible without a working crystal ball. In other words, it is impossible. Nonetheless, you need to make a reasonable and educated guess in order to project your future finances. Historic average rates of return can be a good way to make a reasonable projection.
However, a reasonable average can be hard to pin down. The average can be vastly different depending on the specific time frame you consider, asset class, and how you are defining rate of return.
There are numerous factors to consider when projecting your rates of return, including:
An average rate of return can be vastly different depending on what time frame is being measured.
In general, you can see a lot of volatility in short time periods, and much less over the very long haul.
In other words, over short time periods you could see a much higher (or a much lower) rate of return. A longer time period can be “more” average, though major variability can be seen depending on the exact years being used, even over a 5- or 10-year average. One year of huge growth or losses can have an outsized impact on the average.
Reasonable projections for rates of return will vary greatly depending on the asset class. For example, are you projecting an individual stock, index fund, bond, commodity, or cash? In general, stocks have a higher (though more volatile) average rate of return than bonds.
When planning, you can project one blended rate of return for all of your investments, or project returns for:
With the NewRetirement Planner you can try different scenarios for setting up your accounts and PlannerPlus users can specify specific rates of return and run different scenarios to assess future financial security for any type of account or asset class configuration.
And, with the NewRetirement PlannerPlus Monte Carlo functionality, higher rate of return investments (e.g. stock index funds) automatically carry a higher volatility characteristic than lower rate of return investments (e.g. bond funds).
It is easy to build a comprehensive and personalized financial plan and get reliable answers.
Nominal: Your nominal rate of return is the amount of money you make from an investment before factoring in expenses such as taxes, investment fees, and, most importantly, inflation.
Real: Your real rate of return is your actual rate of return minus those factors, particularly the inflation rate.
So, if your investments returned 7% in the last 12 months ending in October of 2021, your “real” rate of return for that time period is only 0.8%. (The annual inflation rate in the United States for the 12 months ending in October 2021 was 6.2% according to the U.S. Labor Department.) And that considers neither investment fees nor taxation.”
(7% minus 6.2% equals 0.8%.)
NOTE: In the NewRetirement Planner, you enter your nominal rate of return. Projections are in future dollars, inflating the cost of goods and services and using nominal returns over time. We also automatically model federal income taxation and capital gains tax. PlannerPlus members get state-specific income tax projections and can model what relocating to another state may do to their income tax burden.
A linear projection uses one rate of return. That rate is applied to all future time periods. With retirement projections, a linear projection is meant to imply your average return for all future years (i.e. your assumptions are applied equally year over year).
However, linear projections will never be wholly accurate. Assets will rise and fall — sometimes dramatically — in different time periods.
Therefore, when planning for what might happen with your money in the future, it can be important to also consider possible (probable) fluctuations for your rate of return. A Monte Carlo analysis is designed to give you insight into that variability.
The NewRetirement Planner predicts your outcomes in 5 different ways:
NEW: Using the NewRetirement Planner, you can now model a future increase or decrease on your projected rates of return for both linear and Monte Carlo projections on individual accounts.
Sometimes historic rates of return are reported as a compound annual growth rate (CAGR).
In the NewRetirement Planner you should enter an annualized growth rate (not compound) and the system will assume reinvestment. (Or, you can model withdrawals if that is what you want to happen.)
The average rate of return for the S&P 500 is around 10%. (Adjusted for inflation, the average annual real return is 7%.)
However, there is huge variability by year. Between 1986 and 2019, the S&P 500 saw:
NOTE: The S&P’s year to date total return for 2021 is 25.97%.
According to J.P. Morgan, the following are the 20-year annualized returns by asset class for 1999–2018:
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According to Morningstar, the compound annual growth rate (CAGR) for 1926 through 2019 was:
Fidelity reports historic compound annual growth rate (CAGR) for 1926–2020 by asset allocation strategy:
Conservative Strategy: For a conservative portfolio (50% bonds, 30% short-term investments, 14% US stock, and 6% foreign stock), the average CAGR is 5.96%.
Balanced Strategy: For a balanced portfolio (40% bonds, 10% short-term investments, 35% US stock, and 15% foreign stock), the average CAGR is 7.98%.
Growth: For a growth portfolio (25% bonds, 5% short-term investments, 49% US stock, and 21% foreign stock), the average CAGR is 9%.
Aggressive Growth: For an aggressive growth portfolio (15% bonds, 0% short-term investments, 60% US stock, and 25% foreign stock), the average CAGR is 9.7%.
As reported on the A Wealth of Common Sense Blog, here are the real (after-inflation) returns for different time periods:
Over the last 5 years (2016–2020):
Over the last 10 years (2011–2020):
Last 25 years (1996–2020):
Last 50 years (1971–2020):
Last 100 years (1921–2020):
There is no wholly accurate way to answer this question. However, here are some tips:
Okay, you have heard it before: “Past results are no guarantee of future performance.”
However, past results are a reasonably predictive metric, especially between different asset classes if you understand the factors listed above.
You can get more accurate projections by detailing your rates of return with as much specificity as possible.
Look up historic average rates of return by each of your specific investments.
Your asset allocation should be determined by your goals, time horizon, and risk tolerance.
When any of those factors change, you may want to shift your target asset allocation (and therefore your projected rates of return).
Age is the most predictable factor that may change your target asset allocation.
You can use the NewRetirement Planner to change your rates of return at a future time. Project one rate of return now and then predict another rate of return starting on a future date.
With the NewRetirement Planner, you can project your rates of return using an optimistic and a pessimistic rate.
You can also evaluate your results using Monte Carlo projections.
By looking at these different metrics and even running multiple scenarios for optimistic and pessimistic (and changing your future returns) you can gain confidence that the money you need and want for the future will be there when you need and want it.
If you will be holding an investment for a short period of time, be aware that you are at risk of greater volatility in the near term.
If you are holding an investment for a longer time period, then you can maybe more confidently use historic averages.
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