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The Effect of Returns on Planning Projections

I recently wrote about why I Hate Predicting Investment Returns.  As I continue to meet with clients and potential clients, the reality of return expectations continues to be a necessary part of the discussion.  Toward the end of the previous post, I made the statement, “This (lower return) expectation is being baked into my discussions with clients and the planning projections we do.”  Here is what that means in practice using an example.

Let’s say our work together with a client has determined that one of our moderate growth portfolios is the best fit for their need for return, balanced with their tolerance for risk.  The long-term expected return is about 8.0% for such a mix of assets.  But, what happens if returns are lower over the next several years?  Projecting at 8.0% when returns turn out to be lower will show false long-term plan success.

To address this, we began altering our near-term return assumptions over the last 2-3 years as stock valuations have grown.  (Actually, the 8% has been a little below 8% for longer than that to reflect lower bond yields.)  So, we are now assuming a reduction of 1.5% to 2.0% in this asset mix to reflect lower assumed returns.  The actual amount and number of years for this assumed reduction varies depending on the client situation, so there is customization at the client level.

What most people want to know is, “Will I/we be OK if the market has a down-turn or just simply grinds along for several years with lower returns?”  This is an important question to answer.  Continuing with our example, let’s say our moderate growth client’s plan shows an 85% probability of success based on unreduced projected returns (and let’s say 70-90% is a good range to be in).  When we then discount the next several years’ return by 2%, the probability of success drops to about 50%, not an acceptable level!

The plan needs to be in an acceptable range when assuming lower returns.  For the client whose plan shows 85% success while assuminglower near-term returns, it is much easier to address the “will I be OK?” question.  Let’s say that client lives through a 45% decline in stocks, which translates to a roughly 27% decline in their portfolio value.  At that point, a $1,000,000 account has dropped to $730,000.  That’s the bad news.  The good news is the market will have a higher return assumption from that point which will be reflected in our planning.  Starting then from the lower $730,000 value AND normal return expectations, we find the plan still has roughly the same 85% long-term probability of success!

Walking with clients through this process during the ups and downs of market cycles is, again, where I believe the real value in financial advice shows itself.  Finally, a few closing thoughts about this concept and the above example:

  • The above example is one, specific example and is in no way representative of all scenarios.  Specific variables, such as the time to retirement, life expectancy, other sources of income, spending goals, etc. will all have varying affects in each client’s plan.
  • Our market return assumptions will certainly turn out to be wrong, but we believe them to be reasonable, which is as good as it gets.
  • Some would say altering return assumptions over time is rigging the system to achieve a desired answer. We believe it is acknowledging market realities and setting better expectations, while not losing sight of the long-term.
  • Having a plan in place based on flexible assumptions is better than using pie-in-the-sky historical return assumptions or having no plan at all.


Any information presented here is general in nature, believed to be reliable as of the date published and is not intended to be and should not be taken as legal, tax, investment or individual financial planning advice. Competent, licensed professionals should be consulted when implementing any kind of financial, estate, tax or investment strategy.

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