Realistic Financial Assumptions

Do you remember the fable about the ant and grasshopper? The ant, operating on realistic assumptions, amply prepared for winter. The grasshopper, operating on assumptions of perpetual plenty, was unprepared to survive the winter. Financial planning is like that fable. Realistic assumptions based on a long-term, balanced plan will help you prepare so you won't be left in the cold.

Look Behind to Plan Ahead
For example, let's say you have an investment currently earning 19%*. If you believe this is the only investment you need for financial security, your assumption may foil your financial plans.

Here's why.
Average returns can vary widely, so it's important to view the larger picture before making investment decisions. For example, let's compare rates of return for the S&P 500 Index during various periods. Long-Term Annual Average Returns**
Large-Cap

Period	Stocks	Inflation
1990-99	18.2%	2.9%
1970-79	5.9	7.4
1950-59	19.4	2.2
1930-39	-0.1	-2.0
1926-99	11.3	3.1

As the above table shows, returns are inconsistent within the investment period of 1926 to 1999. Knowing this, let's calculate the earnings of an investment receiving 18.2% returns, as large-caps did from 1990 to 1999. A $10,000 investment earning 18.2% annually would grow to $654,000 in 25 years. But at the average annual rate of 11.3%, as from 1926 to 1999, it would grow to $145,000. Although that difference alone is enough to make you want to re-evaluate your assumptions, it's not the only consideration.

Investing Costs and Inflation
Other factors also affect your returns. Investment costs such as brokerage commissions, fees and operating expenses lower your returns. Annual expenses vary depending on the kind of investment. Although an annual expense of 2% or 3% may seem small when the annual return is 19%, it looms large when returns are low or negative. State and federal income taxes can further erode the return on your investment. Inflation also affects your investment returns. Recall the inflation variations in the preceding table. During 1970 to 1979, inflation averaged 7.4% annually. The 5.9% rate of return on large-cap stocks was reduced to an inflation-adjusted, or real rate, of 1.5%.

Balance Is Key
A balanced portfolio can help offset the fluctuations of the markets. Once your long-term plan is in place, resist making alterations based on market movements. To develop a financial plan that incorporates realistic assumptions about the economy and the financial markets, call a financial professional located at Union Bank & Trust to help.

 

* Return shown is for illustration purposes only and does not reflect the return of any actual investment.

**Source: Ibbotson, SBBI 2000 Yearbook.

*Investment services offered through Union Bank & Trust Company’s Trust Division.
Investment products: Not FDIC Insured - No Bank Guarantee - May Lose Value.