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  • Writer's pictureBob Brooks

Is It Easy to Average 12% A Year with Your Investments?


Pop Culture Finance tends to make money appear as if it is to manage, easy to accumulate over time, and that success is almost guaranteed if you follow a simple set of rules. 


This is why it is important to know the other side of the story and create your own beliefs about how money works. The latest from a "Finance Guru" had some things to say about saving money for retirement versus tying up your money in a new car loan. The gist of his advice was to save up cash to buy a used car, take the payments you would have paid on a new car, and invest it towards your retirement. 


Before I go on, most people don't have that kind of cash lying around enabling them to buy a used car. Most people are barely making it paycheck to paycheck. Sorry, I digress.   


Here is what he had to say about his idea of foregoing the new car and investing that money into retirement instead: 


"Financial Guru suggests that not having a $725 monthly car payment would allow Americans to invest that money in a 401(k) or Roth IRA. He says that based on a 12% average annual rate of return, one could retire with more than $8.5 million after 40 years."

The idea of taking a sum of money and investing it over 40 years, foregoing other monthly uses for that money, is pretty much finance 101. However, implying that you could easily make 12% a year on average builds false hope. If only investing worked that easily. 


An S&P 500 index fund, if held for the past 40 years, would have averaged 11.62% a year. The past 40 years were pretty impressive. Does past performance guarantee future results? No, it does not, and to assume it will is dangerous.   


Here is the most important takeaway: If you plan for your retirement and expect a 12% average a year before, you might be sorely disappointed that the law of averages did not work in your favor. What is worse is you might find yourself ill-prepared for retirement. 


I have no idea why the above-mentioned financial guru would use such a high number. Although I am aware of what history says, I would encourage you to go with a much lower growth average when it comes to retirement planning and average rate of growth. You don't have decades to waste in the event you were wrong. 

 


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