Projecting future market returns is far more than an academic exercise. It can mean the difference between a comfortable retirement and spending your golden years worried about making ends meet.

A realistic projection of future returns is a critical component of creating a financial plan. A projection of future returns determines if goals are achievable, the level of savings needed to reach a goal and when the goal can be achieved.

The return earned by an investor is what ties together all the components of financial planning. What you want to achieve, when you want to achieve it and how much you need to save.

Over the long-term even small changes in returns can have a profound impact in the outcome achieved. Saving $1000 a month for retirement over 30 years with a 7% return results in a portfolio of $1.169m. Earn an 8% return and the total size of the portfolio is $1.408m.

Making up the $239k difference between a 7% and 8% return requires saving and investing for ~2.5 years longer or savings $1205 a month over the original 30-year timeframe.

Do investors have realistic return objectives?


The 2023 Natixis Investment Managers Survey asked individual investors around the world their return objectives. The results show that many investors are anything but realistic. The most optimistic investors were Americans.

Even after a sobering 2022 when the S&P 500 fell 18.01% American investors expected long-run returns to exceed inflation by 15.6%. If inflation falls to the Federal Reserve target of 2% that means nominal returns of 17.6% a year.

In Australia investors long-run return expectations are 12.8% above inflation. This is also wildly optimistic when the RBA’s 2-3% inflation target is added.

The same scenario of saving $1000 a month for 30 years at the average Australian nominal – or above inflation – return expectation of 14.8% results in a $5.345m portfolio.

Australian financial advisers are far more conservative. They expect returns of 6.9% above inflation or an 8.9% nominal return assuming we hit the low end of the RBA target.

And me? I use a 7% nominal return in the projections for my own portfolio. Does this make me the world’s biggest bear? Possibly. I’ve been called worse. But there are some caveats.

What does history tell us?


It can be perilous to rely on history as investors. We reflexively anticipate the recent past to continue. This blinds us to risk while providing further impetus to chase returns. But the longer the time period we use the more valuable the past can be as a harbinger of the future.

According to Vanguard the Australian share market has delivered 9.8% per annum over the past 30 years. The US market has returned 11.7% per annum over the same period. This is more in line with adviser estimates. It is significantly below the expected returns of individual investors. I continue to lag advisers, investors and history.

What returns do investors receive?


Market returns are a good starting point. But in the real world we don’t receive the same return as the market. And to be fair the Natixis survey simply asked respondents for overall returns. But in a portfolio projection we need to account for anything that detracts from investor returns.

There are investment fees. They can be low if we choose the cheapest index funds. They can be meaningful if we choose expensive actively managed funds. Individual shares don’t have management fees. But it isn’t easy to meet the market return picking shares.

There are other fees associated with investing. Advisers charge fees. Super includes admin and other fees. There are transaction costs to buy and sell different investments. The buy / sell spread takes a another cut from overall returns.

And the elephant in the room is taxes. Tax situations vary by investor and they are impacted by behaviour given the higher capital gains taxes on short-term holdings. We can explore an example using the 14.8% return expected by Australian investors.

Saving and investing $1000 a month for 30 years results in a $5.345m portfolio. The total amount invested was $360k meaning gains on the portfolio of $4.985m. Those returns are made up of capital gains and dividends. Since the year 2000 60% of ASX returns have come from dividends. We can carry this ratio forward.

If we apply a 32.5% marginal tax rate and assume all capital gains receive the 50% discount for long-term holdings the tax bill over the 30 years is $1.296m. That leaves the total portfolio value at $4.049 with a pre annum return over 30 years of 13.4%.

Looking at the more realistic historical returns of the ASX over the past 30 years of 9.8% the same tax scenario would reduce returns to 8.5%. At the 45% marginal tax rate the return would drop to 8%.

For super the 9.8% would be reduce to 9.2% assuming the capital gains were realised prior to pension phase. Fees, transaction costs and poor investor behaviour further dampen returns.

The value in conservatism


I’m not confident that returns going forward will match what we’ve had over the last 30 years. Valuation levels are higher which reduce future returns. An issue we explored in our podcast episode with Matt Wacher the Chief Investment Officer for Morningstar Asia Pacific.

Maybe returns will match what we’ve experienced over the past 30 years. Maybe they will exceed them. As an investor I will take that. But when creating my own financial plan there is a value in conservatism. Over the long-term my portfolio will get more conservative as more defensive assets are added which will also dampen return.

The point of putting together a financial plan is to assess if a goal is realistic and develop a saving plan that allows an investor to accomplish their goal. Under saving earlier in life is something that is very difficult to make up for later in life. The scenario I’ve used throughout this article is 360 monthly investments of $1000. But each of those portfolio contributions is not equal.

Saving $1000 with 25 years left in a 30-year plan is worth $5427 at a 7% return. The same $1000 nets $1402 with 5 years remaining. Conservatism pays off in the long-run no matter what returns are actually achieved.