Does your retirement plan assume that you will earn average returns on your investments? If so, your plan may be at risk. This post explains why. It is certainly possible that you will earn average returns. However, that is only
one of the possible outcomes -- many of which are significantly
worse than average. Unless you have an understanding of the
variability of stock market returns, you will likely overestimate the likelihood that your retirement plan will work.
In this post, I am again taking the viewpoint of an investor planning for retirement. We'll assume the same situation we assumed in
Don't Plan Retirement Assuming Average Stock Market Returns. That is, we have a 45 year old who wants to retire at age 65. He has received a $100,000 inheritance, and wants to accumulate $670,000 in the 20 years remaining before he retires. It turns out if he receives the average 20-year percentage return in my Dow history database, his ending portfolio will be about $670,000. Do you think if he invests the $100,000 in the stock market at age 45 then all of his retirement planning problems are solved? Think again.
How Much Will Your Stock Investment Grow? What Will $100,000 be Worth Invested in the Stock Market for 20 Years?
(Note: if you want to know what $100,000 will be worth invested at a fixed rate of return (e.g., in Treasury Notes/Bonds or a CD), or NOT invested, see footnote.)
The Variability & Distribution of 20-Year Stock Market Results
In
Range of Stock Market Returns in Dollars, we looked at the increasing gap between the best and worst outcomes as the holding period went from 10 to 100 years. From the high-low bars in that chart, we saw that