How Real Returns Get in the Way of a Good Plan

Projecting investment returns is a common and useful thing to do when planning for retirement or any long-range goal. Having a plan is important.

It’s just not always very realistic.

When talking about market returns, most online calculators and simulations use some given rate of return. Many times, the calculator will default to 8% or something similar. Lots of times, people will put in 10% (the commonly cited return for a stock portfolio). Out comes your result – you’ll have $5 Gazillion after 30 years.

But real markets don’t work that way. Some years they’re up, some they’re way down. Volatility is the neglected factor in most all online calculators. I decided to do a quick simulation of what the effect of volatility might be.

Below are two tables showing how $200 invested monthly compounds. The table on the left shows a steady 10% return. The table on the right uses actual historical S&P data. The difference in balances is shown in the cell in bold.

So we see that assuming a constant 10% return overstates the balance by $6,894. My point is that it’s important to understand the effect of volatility on a savings plan. The real market doesn’t return 10% (or any other percent) year after year.