Why Your Investment Returns Are Lower Than You Think

Most people have no idea what their investments should be earning.  For those that hazard a guess they usually pick a double-digit figure.  For those that listen to Dave Ramsey you will hear him use 12%.  I love Dave.  He does great stuff getting people out of debt and focused on saving for the future.  Unfortunatly in this case, most people, and Dave, are wrong.

Investment vs Investor Returns

There is a difference between the expected rate of return on an investment, and the rate of return an investor typically sees.  Unfortunately the investor return is significantly lower than the return the investment is producing.  For example, the twenty years ending December 2015, the S&P 500 Index averaged 9.85% a year. A pretty great return.  However, the average investor earned a market return of a measly 5.19%.  If you have read any of Carl Richard’s stuff, you would know this phenomenon as the Behavior Gap.  Carl has a great book on the subject aptly titled The Behavior Gap that I recommend you read. So why is our return typically lower than the market produces?

Because we are tinkerers by nature.  We don’t have the patience to let our mutual funds work for us.  We like to think we are smarter than the market.  Ever heard that you are supposed to “beat the market”?  Human nature takes over, and we end up moving our money around.  We buy and sell shares trying to time the market.  We move money between poorly performing assets to high performing assets because it feels like we need to do something.  When the market goes up we buy.  When it goes down we sell. As a result, we lose big by effectively buying high and selling low.  We leave a lot of money on the table.  When our personal returns are calculated it is significantly lower than if we would have just had a well-diversified, properly allocated portfolio, and just left it alone.

Why do we do this?

Because we are human.  We are social beings.  Often we can be easily influenced by our friends and family.  We spend too much time reading the wrong stuff or watching the talking heads on TV and make investment decisions as result of bad economic news or turmoil in the markets. We are also loss averse, meaning we feel the pain of any losses more intensely than they experience the pleasure of a gain. Perhaps we are greedy which causes us to react and chase the hot stock or we fall for the latest fad such as bitcoin or investing in marijuana.   Think this is far-fetched?  I just had a conversation with an individual who was investing his entire bonus into the marijuana industry (something not that unheard of here in Colorado!)

Investing isn’t an amateur sport. It’s not a competition and it shouldn’t be about beating someone else, or even the market.  To bridge the Behavior Gap and succeed at investing requires a long-term approach. It means staying focused on the end goal and not allowing yourself to be thrown off course by outside influences. If you have been disappointed in the returns from your investment portfolio, then it may be time to examine your own behaviors and make some changes.

Recency Bias

Recency Bias is another factor that plays in to the Behavior GapRecency Bias is where stock market participants evaluate their portfolio performance based on recent results or on their perspective of recent results and make incorrect conclusions that ultimately lead to incorrect decisions about how the stock market behaves.

Humans have short memories in general, but memories are especially short when it comes to investing cycles. For example, a person may look at a recent outcome, such as the stock market dropping 10% in the last 90 days, and decide it is a lousy time to invest.  Conversely, if they see the market going up they will want to jump on the bandwagon.  Here is how it typically plays out:

During a bull market, people tend to forget about bear markets. As far as human recent memory is concerned, the market should keep going up since it has been going up recently. Investors therefore keep buying stocks, feeling good about their prospects. Investors thereby increase risk taking and may not think about diversification or portfolio management prudence. Then a bear market hits, and rather than be prepared for it with shock absorbers in their portfolios, investors instead suffer a massive drop in their net worths and may sell out of stocks when the market is low. Selling low is, of course, not a good long-term investing strategy.

Reversion to the mean

Mean reversion is financial theory suggesting that asset prices and returns eventually return back to the long-run mean or average of the entire dataset. This is why looking at the entire picture is important.  Looking at individual years, or even tens of years, isn’t all that helpful in determining how your investments are fairing.  Rather looking at the holistic picture and determining the mean will give you a good idea on what your returns should be.

Reversion to the mean—RTM, the pervasive law of gravity that prevails in the financial markets—never stops. While its drumbeat is hardly regular, it never fails. For the returns of market sectors, of managed investment portfolios, and even of the market itself mysteriously return, over time, to norms of one kind or another.- John Bogle

Take for example the Russell 3000 Index.  It measures the performance of the largest 3,000 U.S. companies representing approximately 98% of the investable U.S. equity market. These securities are traded on the NYSE, NYSE MKT, and NASDAQ.  From 1998-2017 the Russell 3000 returned an average of 9.022% with a low of -37.31% in 2008 and a high of 33.55% in 2013.  Had you only looked at a few years you would incorrectly assume you were either making a killing, or losing your shirt.  Rather looking at the mean helps you understand where this particular fund has produced over time.

A Reasonable Return

56b28fd46e97c662008b4b2f-750-496It’s relatively easy to predict what the stock market will do over long periods of time, but next to impossible to anticipate what it will do in any given year.  However, I think 10% is a historically reasonable long-term expectation for stock market returns. It won’t get there every year or every decade, but over a lifetime 10% is quite possible.   As an example in all of the 50-calendar-year periods going back to 1928, the S&P 500 had a compound return averaging 11%. So 10% is the rate of return we should expect right?  Not really…


The return of the S&P 500 since 1928 is what we call a nominal return, meaning it is not adjusted for the rate of inflation.  Inflation takes considerable wind out of our investing sales.  The average rate of inflation is 3.22 percent.   That means the real inflation adjusted return for the S&P 500 from 1928 would be only 7.78 percent (11%-3.22%).


Costs matter too.  Say you paid a mutual fund manager 1 percent to invest in his mutual fund.  You would then need to subtract an additional 1% from your average compounding rate of return.  However, say you chose to invest in an index fund instead.  You could only be paying the fund manager at Vanguard a mere .011%; a considerable difference in savings compounded overtime.  The industry average mutual fund fee is .62 percent.


Taxes drag on your performance because you are losing the compounding game every time you have to pay taxes on any of your capital gains. A 30 year study by Charles Schwab from 1963 to 1992 highlights the impact of taxes on your rate of return.  For a high-bracket taxpayer who invested $1.00 in U.S. stocks would have received a nice return of $21.89 if he or she had invested in a tax-deferred account such as a traditional or Roth IRA.  However, if they had invested in a taxable account, then they would have only earned $9.87 per dollar invested; half as much! Another study revealed that the drag from taxes range from .70 percent to 1.20 percent per year on active managed funds and .51 percent per year for passive funds. (Bogleheads, 119).

Why I think 7% is a safe return

If we put it all together we can make an assumption that the stock market may return 10 percent over a life time.  We then must subtract inflation from that figure leaving us with a real return of 7.78 percent.  But we still need to subtract taxes.  In this case I will use the .51 percent figure quoted above.  This leaves us with a net return of 7.27 percent.  Finally we need to account for investment fees. For this example, we will use the industry average of .62 percent, although for many people it will be much higher!  This leaves us with a total compounding annual return of 6.65 percent!

This is a considerably smaller return than advertised by Dave Ramsey.  If someone is relying on a 12 percent return to get them to retirement and that return doesn’t materialize, they are in a world of hurt. A 7 percent assumed rate of return allows us to focus on what we can control; our savings rate.  It takes the guesswork out of the equation.  Because we don’t know what the market will do in the future, we must make a guess on how it will perform or else we will never be able to make an educated choice on how much we need to save.  Using 7% as an assumed return allows us to determine with relative comfort the amout we should be saving each month to meet our retirement income goals.

Keep it conservative

There are some takeaway lessons from this post. If you’re a new investor and you expect to earn, say, 12% or 15% compounded on your stock investments over decades, you’re fooling yourself.  Not to be harsh, but you need to understand: Anyone who promises returns like that is taking advantage of your greed and lack of experience. Basing your financial foundation on bad assumptions means you could overreach in risky assets and put your wellbeing in peril, or retire with far less money than you anticipated and put your retirement in peril. Neither is a good outcome.

For Special Needs Families, you have even less room for error.  For those that must save for a retirement for three, coming up short can have significant impact on not just your own retirement, but the lifetime quality of life for your special needs child.  To ensure you stay on track with your retirement savings and/or Special Needs Trust funding, keep your return assumptions conservative, fight Recency Bias by developing an investment strategy for the long-term, and close the Behavior Gap.

Categories: Investing

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2 replies


  1. Why Women Investors are Awesome and What We Should Learn from Them – Finances for Special Needs Families
  2. The Just Noticeable Difference; Implications for how we Spend, Save, and Invest – Finances for Special Needs Families

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