Financial PlanningRisk

Additional Risk Doesn’t Always Lead to Higher Returns #RiskVsReward #FinancialPlanning

By September 18, 2012 October 4th, 2016 No Comments

While taking on more risk ordinarily leads to higher returns, there are limits to the additional amount of return you may expect by taking additional risk.  I have doubts that you really can adjust your portfolio slightly to change your expected result (and actually achieve it) by a percentage point or two over your investing timeframe.  Stock returns are far too random and variable.  And if your goals require some huge return like 30% per year for the next thirty years, there is no amount of risk you can take that will make it likely for you to attain your goals.

If the return you need is too great, you may need to rein in your expectations.  You can change your asset allocation to a certain degree, but you still cannot know whether you will be successful.  You can only have an idea of whether success is possible or likely.  There is really no way of knowing, in advance, what type of returns you can expect by investing in the stock markets, even over long periods of time.  Read that again if you need to; it is important to understand.

People used to have expectations of the stock markets delivering 10% per year, every year, like a CD, and of course, it really doesn’t work that way.  Stock market returns are random and variable, and come with much more volatility (as measured by the standard deviation of returns) than the public realizes.  The best things you can do are to give yourself a low required return by saving a lot and giving yourself plenty of time.

To give you some perspective, 2004 was the last time the S&P 500 returned around 10%, when it returned 10.88%.  Before that, the last time the S&P 500 returned a positive number less than 20% in a calendar year was 1994 when it returned 1.3%.  Meaning, for an entire decade your returns from investing in the S&P 500 were either greater than 20% or negative.  Even if the average return from a period approximates 10%, it is not the same as receiving 10% per year, every year.

A 10% return in a given year in the stock market is actually highly unlikely.  As far as I know, the stock market as measured by the S&P 500, only returned exactly 10% in 1993. In fact, in the 85 years ending in 2011, the stock market delivered returns between 8 and 12% only 5 times!

While you cannot control what returns you will get in the stock markets, you can influence the two other large variables.  The amount of time you have and the amount of money you invest are two variables that you can more easily adjust to affect the probability of attaining your financial goals.  (Not that they are really easy to adjust, just easier.)  Your rate of return is driven more by the markets and the prevailing economic environment than by the amount of risk you take on.

 

Michael Garry Yardley Wealth Management

Author Michael Garry Yardley Wealth Management

Michael Garry is a CERTIFIED FINANCIAL PLANNER™ practitioner and a NAPFA-registered Financial Advisor. He is a member of the National Association of Personal Financial Advisors (NAPFA) and the Financial Planning Association (FPA).

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