People need to consider the difference between real and nominal.
Nominal is what you see, real is what it actually means
I've noticed that a lot of young investors, trying to plan for their retirement are using 10% as their expected annual return.
They expect that if they can earn a long-term average 10% annual return and reinvest everything, the power of compounding will eventually turn them into multi-millionaires.
Starting out with a house worth $ 400 000, a mortgage worth $300 000.
Savings from their job is about $ 150 000, imagine if they borrow an additional $100-150 000 to invest in the stock market.
Imagine they have to pay interest on all their loans at around 5%
Imagine someone tells them that they can get 10% return from their investments every year.
Seems like the investments might be able to pay off all the interest on your loans and then some.
After the loans are paid off, the investor is much wealthier than if they had not borrowed money to put in the stock market.
But how long does it take to pay off the principle? That makes a big difference in the time the investor ever actually sees any improvement in their standard of living (eg. Having a big wad of cash in your hands at all times).
But here is the most important thing: that 10% number is not guaranteed. In fact, in every document you ever read, it clearly states somewhere that there are explicitly no guarantees anywhere on anything in the financial industry.
So where does this 10% figure come from? From the article I linked last post, the argument is made that this figure is basically a fabrication of the investment advising industry. Why would an investment advising industry pick this figure and promote it as the way to make your retirement dreams come true?
Because it is double the average return of bonds, which averages around 5% annual return over the long run. I'll comment more in the future about this number, but it's also in my original post.
So what happens to people who sign over their money because an investment advisor is telling them it's a 'more efficient' way to make money?
They get convinced that they are 'young enough' and have a high-enough 'risk tolerance' to put most, if not all of their hard earned savings into mutual funds or the stock market. All products which do not promise to repay your capital.
Why do people buy into this? Greed is an obvious answer. So is the lack of good information on the real returns offered in the long-term for the various asset classes.
It's a simple rule: you can't make good decisions without good information. Investment advisors have promoted a long-term annual return from the stock market at 10%, 8%, 7%. It doesn't matter. The truth is, whatever the return has been it is characterized by extreme long-term volatility. You essentially have to hope (for your entire working life) to be lucky when you retire and begin to start drawing on your investments, ask anyone who is experiencing that now (old, tired, lost lots of money and can no longer afford to retire).
The bond market? It fluctuates along with economic cycles as well. But unless the issuer is bankrupt, your principal was protected the whole time.
Bonds have beaten stocks over the past 40 years. That is an entire working lifetime for the average middle class investor. What will the next 40 hold for us? Where should we really think about putting our money? And what should we really expect to earn for doing nothing?