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Investment Returns: The Difference 1% Makes

Cut a pie into 100 slices and what do you have? Barely a nibble. Seemingly an inconsequential share of anything, 1% can actually make a tremendous difference to your financial security. Even fractions of a percent added to investment returns over time can redefine your life in retirement or your net worth.

For instance, if you can increase your average annual investment return from 5% to 6%, that bump represents a fifth better return – and a substantial increase in your options for living.

The Difference 1% Makes on Investment Returns

Let’s assume that you saved well over your career. You’re 65 now and, in addition to your Social Security benefits, you have $500,000 that may need to last 30 years.

A 5% average annual return – reduced 2.5 percentage points for projected inflation (yes inflation is much higher today, but let’s use a more historical rate for inflation) – allows you to withdraw $1,750 pre-tax each month and enjoy, considering average longevity, an excellent probability of not running out of money for the rest of your life.

Increase your average annual return to 6% (make it 3.5% after inflation) and you can increase monthly withdrawals to $2,000 while maintaining a significant probability of stretching your nest egg to age 95.

Sounds great – except that adding a percentage point to your expected returns without accounting for more fluctuation in your investment outcomes is hard given today’s low bond yields.

For the past 30 years, many people have lived well in retirement off bond-heavy portfolios. As interest rates trended down for a generation, bond returns were adequate to exceptional.

Even fractions of a percent added to investment returns over time can redefine your life in retirement or your net worth.

The Golden Age of Bonds is Probably Dead

We have probably left the golden age of bonds. Now global interest rates are near all-time lows and investors find bond returns inadequate to generate enough retirement income.

Bonds saw multiple decades of weak returns years ago, but most retirees then had both shorter life expectancies and company pensions instead of an investment account. Retirees saw far less reason to squeeze a little more return out of money.

With low bond income, many investors feel compelled to seek more investment returns via more money in the stock market or high-yield junk bonds that may deliver better returns and higher income only in exchange for more uncertainty and volatility.

The risk of bond issuers’ default, aka credit risk, is tame right up until it isn’t – sometimes also the moment that some investors ignore issuers’ questionable credit quality while scrambling for that extra point.

Your Written Investment Policy

So how can you walk that narrow cliff trail between risk and earning slightly more?

First, focus on what you can control.

Though this task obviously doesn’t include investment outcomes, you can learn much more about your exposure to risk, reasonably expected returns, and how both match your goals.

A written investment policy (aka an investment policy statement) tied to your financial plan can add a guardrail to that cliff edge, minimizing your emotional and knee-jerk decisions when the market turns temporarily sour.

Here at West Advisory Group, we recognize after many years in this industry, we are truly about ensuring our client’s specific road to financial independence remains clear and on track regardless of the changing seasons or road conditions.

Our road map for your retirement journey is built into our proprietary, signature process, PEAK FORMula, and you can count on that process and our experience to pave the way to a clear, smooth road ahead.

We’re happy to talk you through your concerns, answer any questions, and give you peace of mind when it comes to what’s next on your retirement journey. Give our office a call to see how we can get you started.