When my grandma was alive, one of her favorite things to do was to marvel at the cost of everything in the grocery store. We’d scoot up and down the aisles, and she’d rattle off the cost of a loaf of bread, a sack of sugar, or a pound of butter from her Depression-era childhood. Though not nearly as consistent, either my mom or my dad will regale me with tales of CDs and savings accounts rates from their early adulthood once or twice a year. Anyone who has ever overheard those conversations knows they’re talking about the past. So why are we still talking about investment returns at 10%-12% mark in the present tense? It’s not that I don’t believe in investing; I just don’t believe in those rates. I especially don’t believe in those rates as a guideline for fledgling investors or people who are just trying to get their finances in order in 2016.
Take my buddy Dave Ramsey, for instance. On his website, he touts “The 7 Baby Steps” to get your financial affairs in order. Step four — a whole two steps ahead of paying off your mortgage — is the advice that people invest 15% of their income. Don’t get me wrong. Mr. P and I do this. In fact, between funding each of our pensions at 10% of our salaries and maxing out our Roth IRAs, we’re well over this percentage. My issue isn’t with the premise that investing is smart. It is. My issue is with this statement: “Even a couple hundred dollars a month invested now can make you a multi-millionaire.” I understand compound interest. I understand the fact that the market will recover. But I’m also not certain that this statement reflects the reality of now.
In fact, both on his website and in his books, he espouses the notion that investors earn 12% (or sometimes 8%**) on their money. It turns out, though, if you dig a little bit deeper, he also goes on to say, “From 1992–2011, the S&P’s average is 9.07%. From 1987–2011, it’s 10.05%. In 2009, the market’s annual return was 26.46%. In 2010, it was 8%. In 2011, it was -1.12%.” That’s right. We’ve moved from 12% to a negative number. I understand that the market fluctuates. I understand that investors are thinking long term. But I also think it is irresponsible at best and downright dangerous at worst to talk about these percentages as if they are reflective of the here and now for most beginning investors. Because they’re not. I’m not saying that he should be ignored* for putting the notion of investing in people’s minds. If and when we return to the reality of 12%, excellent. But I do think he should anchor his teachings in the reality of now.
I would never expect to go to the grocery store and pay five cents for a loaf of bread. I would never expect to put money in a CD and earn 10% or 15% on my money. But if I didn’t know better, I could read Ramsey’s advice and expect a much larger return on my investments than what I’m likely to see for quite some time. Instead, let’s teach people how to prepare for the future using the reality of today.
* He should be ignored for composing Tweets like a ransom note author. Stop with the random capitalization, Dave.
** “In fact, if you’d rather project your mutual funds to grow at 10% or 8%—that’s cool with us.” Thanks. I’m much more anchored in reality now.
So Tell Me…Do you still use 12% in your investment return scenarios? If so, why? If not, what do you use for a more reasonable outlook?
I don’t believe we’ll get 12% over the long haul, but we don’t really need to with our plan. We’re also diversified in real estate and I think we’ll do pretty well there.
I think it’s safe to say that picking your years, you can get all sorts of different return rates and make all sorts of points about expected return.
I’m on the wait list at the library for the Total Money Makeover now. Friends tell me there’s good stuff in there, but I have also seen these stats about expected returns that are definitely questionable.
I’m hoping to retire in about 10 years so I’m projecting a lower rate of return during this time frame, of about 5-7%. There isn’t enough time to average out the annual returns to earn 12% each year. I’d much rather be pleasantly surprised than horribly disappointed with my forecasting.
It’s that old adage about preparing for the worst and hoping for the best, right?
I don’t necessarily think 12% returns are absurd. For example, we earn much more than that on our rental property. However, 12% is in line with the nominal historical average of the S&P 500 which includes a period of over 10 years when inflation ran into the double digits, and most years when inflation was over 3% (prior to the early 60s). The “real” returns I think adjust to more 6-8% when everything is taken into account, and most people don’t buy and hold which brings real returns into the 3% range.
I use 7% for illustrative purposes, but I don’t think there is anything wrong with using larger returns for an illustration. The real key is to explain that the savings rate trumps the interest rate for the first 20-30 years of investing.
Pure gold: “The real key is to explain that the savings rate trumps the interest rate for the first 20-30 years of investing.” Love it, Hannah!
The majority of my investments are in real estate, mutual funds and a few stocks. I am looking more at the 7-9% range which has been great. When I do my long term projections I shoot for the 5% range. I feel like this will help keep me focused and better off in the long run. I enjoy the blog. Thanks
12% to me is way too high to project. I think it is best to project your future returns based on a much lower amount, maybe 5-6%. They way if you do get 12% you are way better off. Projecting at 12% I believe will only result in disappointment.
I imagine it would be especially disheartening if you were new to investing in this market. Last year, my Vanguard account was kind of ugly – but I knew what I was getting into. If had imagined anything near 12%, I’m afraid I would have quit right then.
I’m more using a conservative number rather than unreasonable numbers. 7-9% seems reasonable to me.
I personal use 7-8% return for my calculations, but some people are pretty optimistic about returns. I’d rather plan for lower returns and be happy if I get excess cash in my future that have issues with cash because my planning was too optimistic.
Side thought: Unless you’re in lower income brackets, is there a reason you’re doing Roth IRA rather than Traditional IRA? I’m still learning but I was doing Roth, now I’m doing Traditional IRA’s to get my tax bracket down and then I’ll convert those accounts to Roth later on if I’m able to retire early. Stuff is so complex, I just want to know if I’m incorrect on tax laws and retirement accounts.
That’s a great side thought! My husband and I are both teachers with pensions. As a result, Roth IRAs it is. My work also offers a 403b through AXA but the fees are horrendous. Sounds like you’ve got a solid plan!
Nope, I project based on 5-7% because I don’t know how many of our building investment years will include really bad negative years. I’d rather end up being surprised with more money than less 🙂 I also diversified into real estate but I’m also being conservative there as well.
Investing goals, for sure. One day we might dabble in real estate. I agree with you in terms of preferring to be pleasantly surprised.
Yeah, so I don’t do projections at all (maybe one day!)
I have been lucky to have had a really good run, starting investing probably just coming out of the GFC and then enjoying a bumper run (NZ markets have done really well recently – not 12% I don’t think but not that far off either!)
Hello Penny! Count me among those of little faith; I use a 7% return in my expected return. Truth be told, I haven’t cranked out any future value projections in a long time. As you know, we’ve been in hardcore savings mode the last few years, so I’ve overlooked this very basic aspect of retirement planning. Looks like it’s time to break out my trusty financial calculator…
Side note, I picked up a penny today at school and instantly thought of you!
Frugal on, Ed
Hooray for found money! I hope you’ll do a post (or 12!) when you run your projections. Your hardcore savings is so inspiring!
Amen! Love Dave, but this is a pet peeve of mine. We project ours pretty conservatively at 7%.