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The point of this example wasn’t to expect an average rate of return of 12% on your money, Orman tells CNBC.com. Instead, she said, it was intended to teach young investors what time and compounding can do.
“You have no idea how many kids told me, ‘When I heard I opened a Roth IRA, I immediately started putting money in it,'” Orman said.
She said young investors should start now and should not wait. This is due to a concept called compound interest – which is that the money you initially invest and the interest earned on that money will continue to grow.
These investors are starting to learn that — regardless of return — it’s better to start at 25 versus 35, she said.
“Every year you wait, you have less time to accumulate your money,” Orman said. “The less time you have to accumulate your money, the less money you can have.”
Furthermore, investing after-tax money in a Roth account versus a traditional pre-tax retirement account may help boost your returns, as tax rates may increase in the future.
Ramzi was not available for comment.
There’s a reason 12% is used as the standard, according to Blanchett. The average historical returns from 1926 to 2023 are 12.2%, according to a monthly data set called Stocks, Bonds, Bills and Inflation, or SBBI.
But this depends on a simple arithmetic return, which may not accurately reflect all fluctuations, according to Blanchett.
For example, if you have $100 and your portfolio goes up 100%, you now have $200. But if it then drops by 50%, that puts you back $100. The average return, taking returns of 100% and negative 50% and dividing them by two, would be positive 25%. However, your realized return will be 0%, as you are back to your original balance of $100, Blanchette said.
He said another, more complex calculation used by experts, known as compound or geometric returns, would better explain those fluctuations.
“It’s the impact of negative returns that hurt you the most,” Blanchett said.
So, how much can you realistically expect to earn from your retirement investments?
“I would tell them 4% to 6%,” Orman said.
The two examples Orman cited have different returns for a reason, she said. The first example with an average rate of return of 12% is to illustrate the power of compounding. The second lesson is to expect a conservative comeback “because you never know what can happen in life,” Orman said.
Orman’s estimate is consistent with Blanchett’s estimate of 5%.
Investors saving for retirement may see tools that provide return projections. However, it is important to keep in mind how expected rates of return are determined.
For example, Fidelity provides a balance projection for the next lifetime of a NetBenefits account holder that expects a 3.5% return, among other assumptions. Because those time frames tend to be shorter, using historical returns is not necessarily the best strategy for those estimates, and is not intended to be an assumption for long-term growth, according to the company.
Of course, rates of return are not guaranteed.
Much of how much you might expect to earn from your investments depends on your personal asset allocation, notes Brian Spinelli, a certified financial planner and co-head of investing at Halbert Hargrove Global Advisors in Long Beach, Calif., who was No. 8 on the CNBC FA 100 list in 2023.
Investors in workplace retirement accounts typically have a limited menu of options to choose from. If they choose greater exposure to bonds or stable value funds, they can expect lower returns compared to someone who invests more in stocks, Spinelli said.
The goal is to match those allocations to your time horizon, which usually means reducing the size of your stock investments as you get closer to your expected retirement date.
In general, investors shouldn’t make large shifts in asset allocation from month to month, quarter to quarter, or even year to year, according to Spinelli.
He noted that it’s also worth paying attention to the fees you may be charged on your investments. Fees eat into your returns.
He added that in order to continue on this path, it is useful to expect a certain amount of volatility from the beginning. By selling, sitting on the sidelines, and waiting for the market to recover, you may miss out on the market’s best performing days.
“In order to get those returns, you have to stay in them,” Spinelli said. “You can’t try to market time and try to get out and expect to come back to the lows, because you probably won’t make that decision.”