Ed Kennedy; Investing

Whether you’ve got a work-sponsored retirement account (typically a 401k) or an individual retirement account (IRA or ROTH IRA), you probably look at it occasionally to “see how it’s doing.”

But how much should you expect your money to grow if it’s invested in the market?

The answer to that question depends greatly on how you’re investing, what types of investments you’re buying, and your overall risk tolerance.

The stock market has done so well in the last 15 to 20 years that it has become hard to NOT make money as a novice investor. This will not always be the case in the future. Be wary of commentators or advisors who tell you you should be getting 10% or more each year on your portfolio, especially if you’re closer to retirement. A 6% annual increase in your portfolio is a more realistic goal. Some years it will be much higher, other years it may be much lower (even negative).

WHAT DOES IT MEAN GENERATE A RETURN ON YOUR INVESTMENTS?

Returns on your investments are calculated as a percentage of the total money you have invested in the stock market. For example, If you invested $1,000 on January 1st 2020 and your investments are worth $1,050 on January 1st 2021, your investment grew by 5%. If over the next year, your portfolio grows to $1,115, you would have grown your portfolio by 10% that year. Most financial professionals review their portfolio every 6 months to 1 year to understand it’s performance. Most retirement accounts provide statements every month or every quarter that summarize the year-to-date earnings.

WHAT FACTORS AFFECT MY RETURN?

Determining what is a “realistic” return on your investments can be difficult. It really does depend.

Specifically your returns are affected by:

1. Whether you’re buying stocks, bonds, or some combination of both.
2. Whether you’re investing in large, well-established companies or smaller, higher growth companies.
3. Whether you’re purchasing individual companies or a basket of companies through an index or mutual fund.
4. How long you plan to hold onto the investment before selling it (hopefully for a profit!).

WHAT HAS HAPPENED IN THE PAST?

Over the last 10 years, the stock market grew by 15%. But, over the last 20-years, the returns were more modest 6% or 7%. It’s important to note that returns for the S&P 500 and Dow Jones Industrial average are both above their historical averages.

Source: https://www.wealthsimple.com/en-us/learn/average-stock-market-return#stock_market_return_historically 

The Average Annual Return per Year over 35 Years

Another way of looking at the average returns of the stock market is to look at the historical returns over a rolling 35-year period. 35 years is an ideal number of years to have money invested in the stock market before retirement. From 1926 to 1982, the 35-year return of the S&P 500 varied from as low as 8% to as high as 14% annually. The chart below highlights how important it is to have time in the market instead of timing the market. If you made one lump sum investment in 1929, your money would have grown, on average, 8% every year by 1964. If you made one lump sum investment in 1932, however, your investment would have grown by 14% every year, 35-years later. The point here is to spread your contributions into your retirement account over many years to catch the highs and lows of the stock market. 

Source: https://awealthofcommonsense.com/2019/03/the-worst-entry-point-in-stock-market-history/ 

BEWARE OF CHASING 10% RETURNS - 6% IS MORE REALISTIC

10% returns are not sustainable or repeatable. That’s not to say it’s not possible. As we have seen, on average, the S&P 500 has returned between 8% and 14% each year. This does not, however, take into account other factors such as fees, needing to sell your investments sooner than you planned to cover emergencies (a big No-no! in our book!), or longer-term recessions during your peak earning years.

Tried and true professional financial advisors will not usually suggest you build a portfolio around a 10% average return. But, you may hear from some market commentators or friends that if you’re not getting 10% or more you’re a sucker. Not true.

To get 10% returns every single year, it's likely you would need to be buying and selling individual stocks all the time which is like turning the stock market into a casino hall. And what’s that saying about “the house always wins?”

To say it another way, if professional investors cannot secure 10% returns every single year, what makes you think you can do better?

A 6% annual return is much more realistic even if some years are flat or negative.

CHASING HIGH RETURNS IS LIKE THE TAIL WAGGING THE DOG

In the big picture, chasing high returns is kind of like chasing low interest rates in borrowing. When obsessing over your interest rate, you’re letting the tail (interest rates) wag the dog (total loan amount). 

The same is true with returns in the stock market. Rather than building a plan around unrealistic returns, it’s more prudent to build a larger pot of money to invest so it doesn’t need to grow unrealistically for you to build wealth. It is more important to build a large reserve (the dog) than chase high returns (the tail). 

HOW DO I GET STARTED?

Besides taking advantage of company 401k matches, we recommend making sure the following savings structures are in place before investing more aggressively. This is because so many women have negative net-worth due to high debt loads and poor savings structures. Once you're out of debt and have short-term savings in place, you can invest more confidently.

1. Save 6 months of “expected expenses” to cover non-monthly expenses (this is a similar concept to an “emergency fund”)
2. Save 6 months of minimum living expenses in a Freedom Fund to cover an interruption in income.
3. THEN, save 15% to 20% of your net-income in retirement accounts and other investment vehicles (401k, IRA, ROTH IRA). 

Our personal preference is low-fee mutual and index funds but you should speak to a financial advisor about your unique situation before making investment decisions.

Depending on your circumstances, a 6% annual return on 20% of your net-income can grow a substantial nest-egg. We recommend getting your savings in place first before moving onto investing to avoid borrowing against your retirement or racking up credit card debt but still pouring money into investments.

For example, if you earn $50,000/year and contribute $8,000/year to your 401k and generate a 6% return, in 15 years you would have saved $186,000 dollars. That doesn’t take additional contributions, increases in income, or higher than average returns. In 35 years, that same $8,000/year contribution would grow into $891,000 dollars!

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