Personal Finance

Should you expect a 10 percent annual return? No, but you don't need to

Key Points
  • A recent CNBC story quoted an author who said you can become a millionaire by investing just $5 a day, for 50 years — with an annual rate of return of 10 percent.
  • Some readers balked at the "unrealistic" rate of return.
  • In response, CNBC spoke to investing experts and financial advisors about just how feasible that return is for most investors.

A CNBC story that came out last week, titled "With this strategy, 'You can't avoid becoming a millionaire,'" caused quite the stir among readers.

In the article, Michael Taylor, author of personal finance tome "The Financial Rules for New College Graduates," said that anyone could retire a millionaire — if they invested just $5 a day for 50 years.

"The hurdle to being a guaranteed millionaire is relatively small, provided you start early," he said.

Yet some readers balked at the postulated annual rate of return — 10 percent — Taylor based his formula on. That expectation, they said, was a pipe dream.

CNBC spoke to investing experts and financial advisors about just how feasible that rate would be for most investors. Most agreed that, while no one should depend on any one rate — because the market is unpredictable — the heart of Taylor's lesson is still valid: investing early is critical, because of the power of compound interest.

Really high returns don't predict future high returns, if anything they predict lower returns.
William Bernstein
author of "The Investor's Manifesto"

To be clear, Taylor didn't pull his rate out of thin air: The 's annual rate of return over the last 90 or so years has, in fact, been around 10 percent.

But now for the fine print.

First, it would be foolish to count on the future being as fruitful as the past, simply due to how the stock market works, said William Bernstein, author of "The Investor's Manifesto." "Really high returns don't predict future high returns; if anything, they predict lower returns," Bernstein said.

"The only way you're going to get those returns are if stocks get a whole lot more expensive," he added. "The ride isn't up from here."

Bernstein predicts profits in the years ahead to be closer to 6 percent a year, adding that "the most wildly optimistic answer you can get is 8 percent."

In addition to the uncertainty of returns, investors must also contend with inflation.

"Investors are interested in the real returns they derive from their investments," said Steve Hanke, a professor of applied economics at Johns Hopkins University in Baltimore. "To obtain those, one must subtract inflation from the nominal returns generated."

According to Hanke's calculations, from 1900 to 2017, the average annual return on stocks has been around 11 percent. After adjusting for inflation? Closer to 8 percent.

You can't count on anything for five minutes, let alone 50 years.
Ed Slott
expert on individual retirement accounts

Then, most financial advisors recommend you vary your investment portfolio and, therefore, you might not want to have all of your money concentrated in the S&P 500 anyway.

"I'm not a believer in putting everything in one asset class, even if it's a broad asset class," said Allan Roth, founder of the Wealth Logic financial advisory firm. Instead, he recommends investors spread their money between a U.S. stock fund, an international index fund and a high-quality bond fund.

Even if all of your investments are concentrated in the S&P 500, historical returns are rarely helpful in understanding how your own investing journey will turn out, said Ed Slott, an expert on individual retirement accounts.

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"Life gets in the way of everything; all of a sudden you want to buy a house, or you have kids," Slott said, naming events that could trigger you to dig into your investments. "You can't count on anything for five minutes, let alone 50 years."

In addition, he said that the average returns over a long period of time can mean nothing to someone who needs their retirement money, say, amid a recession. "The problem is the dips," Slott said.

But there's good news, he added: You don't need a 10 percent return to make it to seven figures.

He gave an example: if you saved $5,500 a year in a Roth IRA — in which the contributions are after-tax and the withdrawals are tax-free — for 40 years in a row with a conservative 6.5 percent annual return, you'd still retire with over a million dollars.

"That's nothing to sneeze at," Slott said. "If you take small steps over time, you can easily have $1 million in your retirement."

As for the $5 a day? At a 6.5 percent annual return, you'd have around $26,000 in 10 years, $168,000 in 30 years and $667,000 in 50 years, according to Taylor.

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