Performance is unpredictable and a major source of risk. But, it is the critical element in the accumulation and preservation of retirement assets. In fact, it is the most critical element after you accumulate a critical mass of assets. An illustration describes the impact of performance.
- Your current gross annual income is $150,000
- Your current savings rate is 10% per year ($15,000)
- Your accumulated retirement assets are $450,000
- Your investment performance is 10% ($45,000)
In this illustration, performance has three times the impact of savings.
Realistic Expectations: Accumulation Phase
Many Americans have excessive performance expectations that are created by advisors who sell investment products. Advisors sell high performance to reduce sales resistance and increase sales. For example, advisors use higher performing mutual funds to create future expectations for performance. The advisor who creates the highest expectations wins new relationships more than half of the time.
Performance expectations should be based on the long-term historical results of the various asset classes (stocks, bonds, etc.).
Realistic Expectations: Preservation Phase
Most retirees are more interested in capital preservation than investment performance, but rising longevity puts more importance on results. For example, if you are retired and take 4% distributions from your retirement assets, you may need to average 7% returns to offset the long-term financial impact of distributions, investment expenses, and inflation.
Performance expectations should be based on your tolerance for risk, your distribution rate, and the long-term historical results of the various asset classes (stocks, bonds, etc.).
There are several definitions of risk. For example, there is the risk of investing in the stock market. But, there is also the risk of not achieving your financial goals. For example, you do not have enough assets to retire when you want to and live the way you want to. There are several rules that impact your risk tolerance when you accumulate and preserve the value of retirement assets:
- Your highest tolerance for risk occurs in the 25-45 age bracket
- Your risk tolerance declines with age; you have less time to recover
- Your risk tolerance declines again when you retire; you have fewer options for saving additional assets
- Your risk tolerance has to reflect your expected longevity; you retire at 65 and live to be 95
- You have to take some risk to offset erosion: Distributions, investment expenses, inflation, and taxes