Expected return is the average annual growth rate you anticipate from an asset class over the long term. It's a key input to every retirement projection — even small differences of 1–2% compound into dramatically different outcomes over a 30-year retirement horizon.
Expected return is the average annual return an investor anticipates from an asset class based on historical performance, economic fundamentals, and forward-looking estimates. In retirement planning, expected returns for stocks, bonds, and cash are the primary inputs driving portfolio growth projections and determining how much you can safely withdraw.
How It Works
Expected returns are typically expressed as annualized percentages:
| Asset Class | Historical Nominal Return | Typical Planning Assumption |
|---|---|---|
| U.S. large-cap stocks | ~10% | 7–9% |
| International stocks | ~8% | 6–8% |
| Investment-grade bonds | ~5% | 3–5% |
| Cash / money market | ~3% | 2–3% |
Important distinctions:
- Arithmetic vs. geometric return: The arithmetic mean is always higher than the geometric (compound) return. Monte Carlo simulations typically use arithmetic returns as inputs, and the compounding effect (including variance drain) emerges naturally through simulation.
- Nominal vs. real: Nominal returns include inflation; real returns subtract it. A 10% nominal return with 3% inflation is roughly 7% real.
- Forward-looking vs. historical: Current market valuations (e.g., high price-to-earnings ratios) may suggest lower future returns than historical averages.
A portfolio's expected return is the weighted average of its component returns. A 60/40 stock/bond portfolio with 8% stock and 4% bond expectations yields 6.4% blended expected return.
Why It Matters for Retirement Planning
Expected return assumptions have an outsized impact on retirement projections:
- A 1% change in expected returns can shift success rates by 10–15 percentage points over a 30-year horizon
- Overly optimistic assumptions lead to under-saving and excessive withdrawal rates
- Overly conservative assumptions lead to unnecessary lifestyle sacrifice
The expected return also determines the trade-off with standard deviation — higher-return assets come with higher volatility. Asset allocation is fundamentally the process of choosing where to sit on this risk-return spectrum based on your withdrawal needs and time horizon.
A Practical Example
A retiree with $1,000,000 withdrawing $40,000/year sees dramatically different outcomes depending on the expected return assumption:
| Expected Return (60/40 portfolio) | Median Portfolio at Year 20 | Median Portfolio at Year 30 | 30-Year Success Rate |
|---|---|---|---|
| 5% (conservative) | $520,000 | $180,000 | ~75% |
| 7% (moderate) | $880,000 | $650,000 | ~90% |
| 9% (optimistic) | $1,350,000 | $1,500,000 | ~97% |
The difference between conservative and optimistic assumptions is the difference between "worrying about money at 85" and "leaving a large inheritance." This is why stress-testing across a range of expected return assumptions — rather than relying on a single number — is essential.
Frequently Asked Questions
- What is a reasonable expected return assumption for stocks?
- Historical U.S. large-cap stock returns have averaged about 10% nominally (7% real, after inflation). Many financial planners use forward-looking estimates of 7-9% nominal for diversified equity portfolios, accounting for current market valuations and economic conditions.
- Should I use nominal or real expected returns in retirement planning?
- Either works if applied consistently. If you use nominal returns (e.g., 8% for stocks), you must also model inflation separately and adjust spending accordingly. If you use real returns (e.g., 5% for stocks), spending stays constant in real terms. Most Monte Carlo simulators, including Retirement Lab, use nominal returns with explicit inflation modeling.
- Why do small changes in expected return matter so much?
- Because of compounding. Over 30 years, a $1,000,000 portfolio grows to $4,322,000 at 5% vs. $7,612,000 at 7%. That 2% difference nearly doubles the final amount. For retirees, lower expected returns require lower withdrawal rates to maintain the same probability of success.