The answer depends on several factors, including which assets you’re invested in and your risk profile. We’ll look at a number of risk assets to get an idea about what a realistic rate of return can be in retirement while also factoring in risk profiles.
Risk Profile
The old adage that higher risk generally equates to higher returns generally holds. Those who are younger tend to take on more risk than those who are older. The main reason for these differences is the time horizon.
If you have 30+ years before retirement, short-term fluctuations in the market aren’t going to matter much. But market fluctuations are an important factor for those who are about to retire in less than five years. This is mainly because retirees don’t want to take distributions in a down market, which can deplete their retirement principal disproportionately.
Those who can tolerate higher risk can assume better returns. For asset classes with lower returns, leveraging them up (i.e., taking on more risk) can create potentially better returns. Of course, on the flip side, this can also create larger losses.
If we break down three asset classes, bonds, real property, and stocks, by risk profile, we’ll get something that looks like the following, historically speaking:
Bonds — low risk, low return
Real property (i.e., real estate) — medium risk, medium return
Stocks — high risk, high return
Note that when we say real estate, we mean real property rather than REITs.
Rates of Return By Asset Class
When it comes to returns, the asset class matters; the configuration of asset classes in a portfolio is determined by the investor’s/retiree’s risk profile. Let’s look at the above three asset classes within the context of risk profile.
We’ll use three different risk profiles — conservative, moderately conservative, and moderate. We’ll define these configurations using data from Charles Schwab.
- Moderate (ages 60-69): 60% stocks, 35% bonds, 5% cash equivalents
- Moderately Conservative (ages 70-79): 40% stocks, 50% bonds, 10% cash equivalents
- Conservative (ages (80+): 20% stocks, 50% bonds, 30% cash equivalents
For retirees, bonds generally make up a large portion of their portfolio. You can see this in the above configurations for those 70 and over. Retirees need to avoid volatility since distributions make up a large part of their retirement income. Treasury bonds are fairly stable but produce a small income. Stocks are still held in these configurations as they are the main income generator.
What do returns look like for these portfolios? As we move from higher to lower risk, you’ll see returns are the inverse, which is expected.
- Moderate:
- Best year: 31%
- Average annual return: 9%
- Worst year: -21%
- Moderately Conservative:
- Best year: 27%
- Average annual return: 9%
- Worst year: -13%
- Conservative:
- Best year: 23%
- Average annual return: 7%
- Worst year: -5%
One might contemplate the advantage of the Moderate vs. Moderately Conservative portfolio given the larger drawdown potential. Both portfolios returned an average of 9%, but the Moderate portfolio has nearly 2X the drawdown. This goes back to risk profile. If an investor can tolerate the larger drawdown, they may view the potential +4% as worth the risk.
These configurations show that retirees should expect a 7-9% annual return, depending on their risk tolerance. By working with a financial adviser, you can determine your risk tolerance and overall portfolio configuration to meet your financial goals.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.
All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure.
A bonds yield, share price and total return change daily and are based on changes in interest rates, market conditions, economic and political news, and the quality and maturity of its investments. In general, bond prices fall when interest rates rise and vice versa. You could receive back less than you initially invested and, unless otherwise noted, there is no guarantee that you will receive any income.
