Investors have enjoyed juicy equity returns for the past several years. Now there is evidence that many investors have become accustomed to the higher market returns and are projecting more of the same for their future.
According to a BlackRock survey of retirement plan participants, “66% of surveyed workers believe that over the next decade, returns on their savings will continue to be in line with what they have experienced in the past…while 17% believe they will experience even higher returns.”
Given that most of these investors have experienced bull-market returns for the past nine years, believing that future returns will remain even or climb higher requires some serious optimism.
Now, there is nothing inherently wrong with a little wild-eyed optimism. Unfortunately, in the real world misplaced optimism can result in self-delusion—which can be a dangerous thing for investors.
How Optimism Can Be Dangerous
One danger of being overly optimistic is the risk of believing current market returns will continue or even accelerate, and then making contribution decisions that will result in a financial shortfall. Building a robust investment portfolio is a tough task. Ideally, you need to begin saving early and continue saving for several decades, which takes discipline and determination. But some investors may skip some contributions in favor of vacation or a new car because they have an overly optimistic view of expected market returns.
A second danger is failing to account for risk tolerance. Few long-term investors are willing to put all their money into high-flying stocks. If you are a cautious investor, but your financial future depends on an unrealistic view of investment returns, you may be in for a dose of tough reality. A portfolio that is structured to account for your risk tolerance level will likely never match pure equity returns. Prudent investors—and certainly cautious ones—build well diversified investment portfolios that include a variety of assets, such as bonds and other asset classes, in addition to equities. As a result, they give up some return in order to reduce potential downside risk.
If you think you tend to overestimate expected portfolio returns, seeking out a professional advisor may help you avoid a potentially dangerous thought pattern. An advisor will typically look at your historical data, asset allocation, risk tolerance, and your contributions to help you understand what future returns may look like.
While no one can predict long-term returns, trusted financial advisors strive to implement disciplined strategies based upon an individual’s financial picture, goals, and risk tolerance; rather than making decisions based upon emotions. If you accept a more realistic assessment of long-term returns, you will be less inclined to skip contributions—and you might even increase them.
Understanding how your portfolio is expected to behave based on its risk level often leads to better long-term planning.
Craig Birk, CFP®
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