2021 SFG Q3 Newsletter Update

July 09, 2021

Many clients over the years have inquired about investment returns and wonder what should a reasonable expectation be for long-term returns?  As with many things in finance, the answer isn’t simple or straight forward: it depends. Investment performance has to do first and foremost with the overall allocation of your portfolio, but other key drivers include how long you remain invested and whether or not you are reinvesting your earnings – versus taking income from the portfolio, which in reality is really a withdrawal of earnings (or principal). Obviously there are other factors such as the specific investments chosen, when you invest and a myriad of other variables can impact returns as well.   

I wanted to focus on just one aspect of an account’s earnings, the decision to reinvest dividends. This decision allows the account to benefit from compounding more fully, versus treating dividends as income and withdrawing them. Note: this is an important decision, especially given that many of our clients are 50% or more invested in stocks.

According to a recent study by Morningstar and Hartford Funds, reinvested earnings in the form of dividends account for 41% of all stock market returns, on average, looking back at 90 years of data; and that figure is representative of numerous other studies I have examined over the years that showed a 25%-50% contribution of such reinvested earnings.  As we reach that point in life when we need to draw on portfolios to support our income needs (and that was the point of saving for retirement, right?), we need to recognize that returns will necessarily be lower since portfolios won’t have that critical source of return in the form of reinvested earnings and dividends. That is also why we frequently talk to clients about taking a reasonable 3-5% cash withdrawal rate from their portfolios over time, to give the maximum opportunity for some level of compounding of reinvested earnings.

With the Forward S&P 500 Price/Earnings ratio hovering around 22, some 20-30% above long-term averages, we are prepared for increased volatility in the months and years ahead – see Berkeley Harrison’s article on this very topic inside on page three.  As we consistently remind clients, investing is more like a marathon than a sprint and we look forward to assisting you over the long-term. Please let us know if you have questions about these topics and we look forward to speaking with you soon. Have a great summer, going to a ball game, traveling, hiking or wherever your adventures take you!

—Best regards, Michael