Being Realistic about Your Investment Returns

It would be nice to think that holding your stocks long-term would result in amazing gains over time. And, while a long-term investing strategy is one of the best ways to build wealth over time, it’s important to realize that you still need to be realistic about your expectations. Too often, we have this idea that picking the right stock will lead to amazing returns in the next couple of years. Or we might think that we can see 10% annualized returns when we invest for 20 or 30 years. The unfortunate reality is that these expectations are likely to be disappointed in a rather dramatic fashion.

Huge Returns in a Short Period of Time are Rare

In spite of plenty of evidence to the contrary, there is still this idea that it’s possible to see huge returns in a short period of time. Double my money in one year? Sign me up! Unfortunately, it doesn’t work like that for most people. In order to see big returns in a short period of time, you have to meet the following criteria:

Have a large amount of capital to invest.

Take on a great deal of risk.

Be very, very lucky.

Those types of huge returns only come when you are willing to take a big chance. However, there is just as big a possibility that you will fail as there is that you will succeed. If you can’t afford that kind of a risk, you could find yourself in big trouble.

Identifying which investments are likely to hit it big in the next few months involves a great deal of knowledge and skill, and a huge amount of luck. No one knows what the markets will do, and there is no way to predict it.

And, if you are measured in your approach to investing, reducing your exposure to risk, you really can’t expect huge gains in a short period of time. A boring investor knows that long-term success means giving up the (usually small) possibility of huge short-term gains. Be realistic about what is going to happen in the short run, and instead focus on the long-term.

Be Conservative in Your Estimates of Returns

Even when you are planning for the long haul, it’s possible to over-estimate your chances of seeing big gains. When planning for the future, particularly when trying to decide how much you should invest each month to see your desired end result, it’s better to be conservative.

Using one specific method, the S&P 500 has annualized returns of 9.62% from the beginning of 1957 to the end of 2011. However, what you end up with depends on other factors, including major events during the time your were investing. The cycle you are a part of has a lot to do with your success over time.

While historically you are likely to see gains over time, the reality is that you might not even see returns approaching 10%. Since 1871, a version of the S&P 500 (including precursors to the actual S&P 500) has seen annualized returns closer to between 5.63% and 5.85%. During the last 20 years, those annualized returns have been between 7% and 8%.

As you can see, you are better off making conservative estimates about your likely returns over time. Estimating returns of between 5% and 7%, rather than relying on optimistic estimates made by those who thought we had hit a “perpetual bull market” and could see between 10% and 15%, is more likely to lead to success during the long haul.

Yes, investing that includes the stock market is one of the most likely ways to provide you with long-term wealth building success. However, you still need to be realistic in your estimates of what’s going to happen. With the realities of long-term returns, investing a couple hundred dollars a month isn’t likely to do the trick for you. But deciding to risk it all in the hopes of seeing huge short-term gains probably won’t help you, either.

Instead, you need to take a measured, realistic approach. You probably need to invest more each month in your dollar cost averaging efforts, and recognize that you probably won’t see such rosy annualized returns. But you can still see long-term success.

Photo by thinkpanama via Flickr.