By Blaine Thiederman MBA, CFP – Founder of Progress Wealth Management
“Can we perpetually skim 10% off our stock investments?” – I hear this all the time.
This is a common belief among those who have unwavering faith in the stock market’s long-term performance.
Now, there’s a strong case for the enduring strength of stocks, as they have historically outperformed bonds and other asset classes over extended periods. However, the notion of consistently extracting a 10% return each year is overly simplistic and incredibly risky. Here’s why:
The Reality of Stock Market Returns
While it’s true that stocks have shown superior long-term returns, their short-term variability is a critical factor that cannot be overlooked.
For example, the S&P 500 has seen years of significant gains, often exceeding 20%, but it’s rare for returns to hover precisely around 10%. It’s essential to remember that the stock market is not a linear, predictable entity. High-return years are often balanced by periods of lower or negative returns, making the idea of a steady 10% withdrawal each year a precarious strategy.
The Risks of Over-Withdrawal
Withdrawing 10% annually, especially during market downturns, can significantly deplete your investment portfolio. Let’s say hypothetically, you started withdrawing 10% in the year 2000 and withdrew 10% per year for the next 10 years. You’d deplete your account by a substantial amount, considering the S&P 500’s performance during this period.
For instance, if you had $1,000,000 at the start, a 10% annual withdrawal would mean $100,000 each year. However, the market saw significant fluctuations, including the dot-com bubble burst in 2000 and the financial crisis in 2008.
By 2010, considering the average annual returns were lower than your withdrawal rate, your portfolio would have been exhausted, leaving you without financial resources in a critical period. This scenario underscores the importance of a sustainable withdrawal strategy, especially in volatile markets.
This strategy might not impact those with a short investment horizon, but it could be detrimental for those planning for a longer future, like 20 years or more. Reducing exposure to market volatility by increasing fixed income allocation could be a safer approach, but it also lowers the expected overall returns.
The Illusion of High-Yield Safe Havens
The alternative strategy of relying on CDs or bonds for a steady 5% return is also fraught with challenges. In the current economic climate, finding CDs or bonds that offer such returns is nearly impossible. The reality is that lower-risk investments typically yield lower returns, which may not keep pace with inflation or meet long-term financial needs.
A More Sustainable Approach
A more prudent strategy involves a comprehensive understanding of your financial goals, risk tolerance, and time horizon. This approach includes selecting an appropriate benchmark and asset allocation that aligns with your long-term objectives. It’s about finding a balance that allows for sustainable, inflation-adjusted income over time, rather than chasing after fixed, unrealistic return percentages.
The belief in a perpetual 10% return from stocks, or a consistent 5% from safer investments like CDs and bonds, is more myth than reality. A wise investment strategy considers the variability of returns, the impact of economic conditions, and personal financial goals. It’s about creating a balanced, well-thought-out plan that navigates the complexities of the market while aiming for long-term success.
Note: This content is for educational purposes and should not be considered as investment advice. Always consult with a financial advisor for personalized investment strategies.