“Get a 12% return on your investments.” Sounds great, doesn’t it?
Well, it’s great until you begin reading the fine print.
You see, these sorts of claims raise eyebrows among professional investors because expected rates of return on a diversified portfolio are often lower.
So then, understanding what goes into your expected return can help make you a more informed investor and to be better prepared for retirement.
What, then, is your expected return?
Well, simply put, it’s the growth you need from one year to the next that helps you calculate your retirement portfolio savings need.
But, if you’re overly optimistic and assume too high a rate of return, you could risk saving too little if markets underperform your expectations.
On the other hand, you could end up forgoing early retirement if your assumptions are too conservative.
So, how can you set a realistic expected return?
Well, start by assessing your risk tolerance.
Here, what you’ll want to do is to consider how you typically react to big swings in the markets.
For example, when the market is volatile, do you panic and think about selling, or do you remain committed to your long-term strategy?
Understanding your reaction to these situations can greatly influence the suitability of different investments for your portfolio.
Next, understand that different investments yield different returns.
That is, stocks are generally riskier with higher potential returns, whereas bonds offer lower, more stable returns.
Finally, pull everything together and build a diversified portfolio of stocks, bonds, and other assets that align with your risk tolerance and investment objectives.
From here, your portfolio’s composition will help you arrive at an expected return based on a realistic set of assumptions.
So, the next time you hear a promise of double-digit investment returns, remember to read the fine print.
And more importantly, arm yourself with the knowledge you need to set realistic expectations based on your risk tolerance and develop a disciplined investment strategy.