Risk vs Return
Maximizing investment returns represent one of the single-most determining factors in achieving your retirement goals. Higher returns usually mean higher risk as shown in the following graph:
Bonds and cash are at the low end of the spectrum, while stocks are at the high end. Where do you fit on the risk curve? People have different tolerances for risk. Many young people may have a larger portion of stocks as they can ride out the downturns in the market, while people approaching retirement are more concerned about preserving their principal thinking it will be needed in the next few years. The majority of people will have some mixture of stocks and bonds. Besides stocks and bonds, other asset classes include:
- Commodities (gold, silver, etc)
- Collectibles (art, coins, stamps, etc)
- Real Estate (rental properties, land speculation, etc)
- Currencies (Bitcoin-seriously?)
The accompanying chart shows the total real return for the past 90 years. Over the long-term stocks have proven to have higher investment returns. Just ask Warren Buffett. This does not mean you should be invested in a high percentage of stocks unless you have 20, 30 or more years until retirement. With only a few years until retirement, you may not be able to withstand a 36% decline that happened in 2008.
Historical Stock and Bond Investment Returns
The Standard and Poor’s 500 Index is the benchmark for domestic stock performance. You will not likely match this performance. In fact, over 75% of professional money managers cannot beat this benchmark. Although the average total return in the S&P since 1950 was over 12%, there were many negative returns. When you smooth the data into 10-year periods, the average return was still over 12%, but during the worst 10-year period (1999-2008), you earned only 0.65% total return. Remember the dot-com and financial crisis? They both happened during that span. When looking at the 20-year smoothing, the average is still over 12% with less variation between the lows and highs.
Bonds are at the other end of the investment spectrum. Bonds include Treasury Bills, Treasury Bonds, and Corporate Bonds. Treasuries at all durations have the backing of the US Government and have a virtually no default risk. Corporate Bonds vary in quality and will pay higher returns for the added risk. Look at a table of bond returns since 1950 to get a feel for the differences. The shorter three-month T-Bill averages just over 4% while the 10-year Treasury Bond average close to 6%.
So, What is My Investment Return?
When using the Charting Your Retirement Calculator, you must enter a Taxable and Non-Taxable Return percentage. If the S&P500 Return Table and the Treasury Bill/Bond Return Table cannot help you decide, a 5% Rate of Return would be a conservative choice if you had a mix of stocks and bonds. If your portfolio had a high percentage of stocks, then 6 or 7% might be more appropriate.