Expecting 12% Return on Your Portfolio?  That’s dangerous

Expecting 12% Return on Your Portfolio? That’s dangerous

The power of compounding is an important concept that investors need to understand. Investing regularly and starting earlier in life (ie, age 25) can result in hundreds of thousands more dollars in your investment account than if you started 10 years later.

While some personal finance experts suggest that a stock investor can expect a 12% annual return, when you include the effect of volatility and inflation, 7% is a more historically accurate estimate. for an aggressive investor (a person who mainly invests in stocks), and 5% is more suitable for someone who invests in a balanced portfolio of stocks and bonds.

The chart below illustrates how much difference account balances can make using different return assumptions, if you save $100 a month in a Roth IRA.

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$100 saved in a Roth IRA over several years.

(Image credit: David Blanchett)

While it’s true that you can achieve a balance of around $1 million if you save $100 per month for 40 years assuming a 12% return, that’s just not possible when you factor in market volatility and inflation. In fact, if we assume a 7% return, which although may be a touch optimistic, it would require saving $400 a month, or four times as much, to generate the same $1 million.

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