Jan 10 / Kyle

Is A Safe 8% Return Realistic?

Over at my other blog, I’m occasionally asked in the comments or (more often) via email whether a safe 8% (9%,13%, etc) rate of return is realistic.  Ignoring the fact that this is far too complex a question to be correctly answered in just a few paragraphs, I’m going to go out on a limb and say “no, not right now and not anytime soon that I can foresee.”

What Constitutes A “Safe” Return?

The kicker, of course, is just what you mean by the word “safe.”  Stocks will likely return 8% or so going forward, but are stocks safe?  Not by a long shot.  You might consider investment-grade long-term bond mutual funds to be more or less “safe,” but they are currently yielding more like 5 -6%, not 8%.  And that ignores the issue of credit risk, which is even affecting the perception of government bonds around the world, these days.  If by safe you mean no or little risk of principal in real inflation-adjusted dollars, long-term bonds are not “safe.”

Tilting towards short-duration, high-quality bond funds (from the Morningstar bond style box) fares you no better, since short-term yields are still paltry.  And it’s quite likely short-term bond yields are below the rate of inflation, guaranteeing you negative real returns if you invest today.  If you define safe as there being a minimal chance of not reaching your financial goals, short-term bonds are not “safe.”

What about real estate?  As we’ve seen, the notion that real estate is a “safe” investment or a “sure thing” has been turned completely on its head.  Property prices can and do fluctuate like crazy, sometimes dropping off a cliff.  The Vanguard REIT Index Fund (VGSIX) currently yields just under 5% and will likely appreciate 3-4% per year going forward (averaged over a very long time horizon), but REITs certainly can’t be considered to be a “safe” investment, at least not by themselves.  REITs do have their advantages over direct investment in rental properties, however.

Investing Is Risk

Now we come down to it:  to invest is to accept risk.  There is no such thing as an absolutely “safe investment,” although some investments carry very low amounts of risk (Treasury Bills, insured immediate annuities, FDIC-Insured Certificates of Deposit, etc).  The basic idea of Modern Portfolio Theory is that risk and return are intimately related.  By taking on more risk, you can expect to earn a higher rate of return in compensation (sometimes, not always).  To ask for a “safe 8%” or a “safe” anything is to ask for a free lunch.  Unfortunately, the market doesn’t give out free lunches.  To devise an intelligent investment strategy is to find the place where your willingness to take risk meets a high probability of earning sufficient returns to meet your financial goals.  If you find the amount of risk you must take to reach your goals is more than you’re comfortable with (a common occurrence), you’ll just have to save more money.  There is no free lunch.

*All facts and figures are accurate as of 1/11/2010

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One Comment

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  1. Daddy Paul / Jan 25 2010

    Investment is risk. The trick is to not take risk without ample reward potental.

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