Even with all of the drama the financial markets have seen recently, 2012 has been an exceptional year. You have most likely received your monthly statements along with your credit card offers in the mail, and you haven’t had to question anything. Most people will look at their most recent balance (market value), make sure it’s higher than the one they received last month, then discard it. This year has been a good year for these people.
If you remember, I highlighted my investment performance in 2012. My 401(k) returned 26% and my Roth IRA returned 11%.
While your investments probably (hopefully?) saw similar results, this is anything but normal.
Historically, (financial advisers love this statistic) the stock market has averaged 7-10% each year. I give a range rather than a number because I’ve seen many different numbers. Who knows which one is most accurate?
Most people see this range and think, “who cares?” I would be happy with 10%, but I would also be happy with 7%.
Why It Matters
When I started working fresh out of college, I’ll never forget the conversation I had with my boss. While showing me the various 401(k) investment options, he told me his exact plan.
“I’m going to contribute X amount. I’m going to return Y% each year. And I’m going to retire in Z years.”
All you need to know is that Y=8.
He had it all figured out. His entire life was based on the thought of him returning 8% each year. I hate to say it, but that’s probably an unrealistic number for most.
Moving forward, I would estimate a modest 3-4%.
How Would You React to 4% Investment Returns?
If I had to guess, most people would be okay with this. Everyone, obviously, wished it could be higher; but, it’s still positive. It’s at least keeping up with inflation (maybe?).
But the difference between 4% and 8% is HUGE. It could seriously affect HOW MUCH you have for retirement. And it could seriously affect HOW MUCH you need to save RIGHT NOW.
Allow me to demonstrate…
Let’s say you are 25 years young making $50,000/year. In retirement, you will need to replace 75% of your income. You expect 3% inflation. How much will you need to save in order to retire by 65 – excluding Social Security? Estimating a 8% return…
You will need to save 8.1% of your income (excluding employee match). The total savings needed to retire – YOUR NUMBER – is $1,498,504.
Keeping all variables constant, but changing the 8% to 4%…
You will need to save 27.9% of your income. The total savings needed to retire is $2,149,451.
Readers: Does this difference concern you?