Setting Realistic Investment Expectations
One of the critical issues for long-term investment success is having realistic expectations. For a hypothetical example, if you put your money in a savings account at the bank, and expect to earn 20% over a year; you will likely be very disappointed when you find that you earned closer to 1% or less.
This is an extreme example, but this happens all the time when people invest in the stock market. A commonly cited expectation is that “long-term stock market returns” average 8% per year*. This is likely a reference to the long-term performance of large cap stocks in the United States. So, the assumption often made is that an investor expects to earn 8% every year if they invest in “the stock market”. There are two main problems with this expectation:
That return average ONLY applies to the part of your portfolio invested in U.S. stocks. Bonds, international stocks, cash, etc. often make up the total portfolio. The long-term returns for these portions of an account are different and have to be considered.
A key word in the expectation above is AVERAGE. We know stock returns fluctuate from year to year, and depending on “when” you invest, your individual average return will vary from the long-term average. This context is important to understand whenever you begin investing in “the market”.
I highlight this today, because many research firms are forecasting “lower than average” market returns for the United States going forward given the strong run since the real estate crash. Therefore, it is key to review your expectations and make sure they are consistent with forward-looking forecasts, and not just rely on historical data.
*The S&P 500 has averaged an annualized return of 8.02% since 12/31/1975
Source: Bloomberg