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As a rule of thumb, it’s almost always better to be optimistic than pessimistic. If you’re overly negative and only focus on the downsides, you’ll often miss great opportunities.
There is one exception, however.
Right now, we’re in one of the greatest bull markets ever. That’s fantastic. I love it, and it’s fun to watch portfolios post massive gains month after month. That said, many investors are starting to confuse "a hot stock market" with "long-term average annual returns."
It’s easy to look at the S&P 500’s 10-year annualized total return of 15.43% and assume the market will always compound at that rate.
Even financially conservative Dave Ramsey recently advised a caller to base their retirement around the market compounding at 12% per year. That’s fine when the market is on a tear, but it’s well above the S&P 500’s actual long-term average.
The S&P 500’s long-term annualized return is around 10%, even after including the recent hot streak. Those are still excellent returns, but they’re significantly lower than what the market has delivered over the past decade. More importantly, if you’re retiring or pursuing financial freedom, you can’t control what the market does during any given cycle.
From 2000 to 2010, for example, the S&P 500 delivered an annualized total return of approximately -0.9%. By the way, that figure includes dividends.
Nobody in 2009 was modeling their retirement around a 12% annualized return.
While I don’t believe in sitting on the sidelines or shorting the market (remember all those people who refused to invest in the late 2010s because they were convinced the market had already peaked?), I do think it pays to be a little pessimistic when calculating the percentage return you’ll need to live off your investments.
That includes modeling dividend growth.
If I were calculating how much of my portfolio I could safely withdraw, or what dividend growth rate I’d need to outpace inflation while living off distributions, I would intentionally lowball my assumptions. Maybe I’d model an 8% annualized return for the S&P 500, or a 4% dividend growth rate for a particular stock if I actually expected it to deliver 5% or 6%.
It’s better to plan for an 8% annual return and be pleasantly surprised by a 10% or 12% return than to plan for 12% and get caught off guard when the market inevitably slows down.
Sound familiar?
Over 4 million people have had the same lightbulb moment.
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Disclaimer: This article is for entertainment purposes only. It is not financial advice, always do your own research.
