166) Project Lower Investment Return

166) Why You Should Project A Lower Investment Return

There are times when you will be asked to project or estimate a rate of return for the investment you proposed. You will be tempted to put a high return rate number to convince your prospect of your investment products.

You may have heard the concept of,

Under Promise, Over Deliver.

and

Lower Expectation, Higher Success;

Higher Expectation, Lower Success.

It basically means, if you put a higher return rate, the chances of achieving the high return is lower. If you put a lower return rate, you will be more confident that it can be achieved.

If the Engineering field, it is called the Margin of Safety. Engineers use a lower number to calculate the required material. It will end up with the design is stronger than required. It is also to create some extra space for unforeseen circumstances.

Similarly in financial planning, you should use a lower return rate for growing money. There can be many circumstances to affect the actual returns. Especially in investments, the situation is very dynamic and very unpredictable.

Let’s do a case to study the impact of over projection. You can use the Financial Calculator app.

Let’s say Ali & Bob are currently 30 years old and both want to retire as a millionaire at age 60. Both agreed to invest monthly using the Direct Debit Instruction (DDI) method. 

Ali is projecting to earn 10% per year.
Bob is projecting 6% per year.

Scenario 1: Ali

Future Value = $1,000,000.

Annual rate = 10%.

Periods = 30 years (360 months).

Compounding = monthly

Payment monthly = $438.73

Note: the "negative" symbol is to show Ali's money was paid out into the investment.

This means that Ali will be a Millionaire if he saves $438.73 monthly for 30 years and the annual return rate is 10%.

Scenario 2: Bob

Future Value = $1,000,000.

Annual rate = 6%.

Periods = 360 months.

Compounding = monthly.

Payment monthly = $990.55.

This means that he will be a Millionaire if he saves $990.55 monthly for 30 years and the annual return rate is 6%.

After 30 years, let's assume the actual return is at 8% per year. 
Let's see what are the amount accumulated after 30 years of investment.

For Ali,

Payment monthly = $438.73

Annual rate = 8%.

Periods = 360 months.

Compounding = monthly.

Future Value = $658,224.50.

Ali is having a shortfall of $1,000,000 - $658,224 = $341,776.

Ali has to find more money to reach his goal to be a Millionaire.

He most probably have to defer his retirement and continue to work.

For Bob,

Payment monthly = $990.55

Annual rate = 8%.

Periods = 360 months.

Compounding = monthly.

Future Value = $1,486,117.39.

Bob is having a surplus of $1,486,117 - $1,000,000 = $486,117.

Bob can achieve his $1,000,000 earlier and have more money for his retirement. 

If the actual return is only 6%, Bob will still achieve his goal of becoming a millionaire.
Let us see what is the amount Ali will have if the actual returns is only 6%.

Ali is going to have $442,914 only. 
It is less than half a million, less than half of his goal.

If you are his financial consultant, how are you going to explain to him that his achievement is less than half of the goal? Who is at fault and who to blame? 

Projecting a higher or lower return will not affect the actual returns.

PROJECTIONS ARE NOT REAL.  
It May or May Not Happen.

The actual returns are based on FUTURE market conditions and investment strategy of the investment. Past performance is never a guarantee that it will happen again. Never use past performance as indication of future performance.

Although it is more impressive to project a higher return rate, the success rate is lower. 
Improve your Safety Margin by using a lower return rate projection.  
 

Having more money will never be a problem. The problem arise when you don’t have enough. The time lost will never come back.  

You cannot go back to the past and start all over again.

It will not help much if you are over optimistic about your investment returns. 

Would you rather have a SURPLUS or a SHORTFALL?

An old proverb says it all.

"Better Safe Than Sorry"

If you want to monitor and track your investments, go to this article and the download an Excel file. You can enter your projected return and update the data on yearly basis. It will show if you are having a Surplus or Shortfall as compared to your projections.

http://highlevelrules.blogspot.my/2017/09/invest-expenses-for-retirement-plan.html