Annual Rate of Return
Expected annual investment return before taxes. Used to project portfolio growth over time. Typical range: 5-9% per year depending on asset allocation.
How it works
The annual rate of return assumption determines how your portfolio grows (or shrinks) over time. This is a NOMINAL return (before adjusting for inflation). Your REAL return (actual purchasing power growth) equals Nominal Return minus Inflation Rate. For example, 7% nominal return with 3% inflation = 4% real growth in purchasing power.
1. Asset Allocation Analysis
Different asset allocations have different expected returns. Conservative portfolios (more bonds) typically earn 4-6%, balanced portfolios earn 6-7%, aggressive portfolios (more stocks) earn 7-9%. Historical data shows stocks averaging 10% (1926-2024) and bonds averaging 5%.
Example: 60% stocks (10% return) + 40% bonds (5% return) = 0.6×10% + 0.4×5% = 8.0% expected return2. Historical Performance Baseline
Review long-term historical returns adjusted for fees and taxes. Actual investor returns are typically 2-3% lower than market returns due to fees, taxes, and behavioral mistakes (buying high, selling low). Use conservative estimates to avoid overly optimistic projections.
Conservative Return = Historical Market Return - Fees (0.5-1%) - Behavioral Gap (1-2%)
Example: S&P 500 historical 10% - 0.75% fees - 1.5% behavior gap = 7.75% realistic return3. Apply to Portfolio Growth
Portfolio grows annually by the return rate via compound interest. This assumes regular rebalancing and reinvestment of dividends/interest. Growth is applied to all asset types (taxable, tax-deferred, tax-free) equally unless specified otherwise.
Future Value = Current Value × (1 + Return Rate) ^ Years
Example: $500,000 portfolio with 7% return → Year 10: $983,575 | Year 20: $1,934,842 | Year 30: $3,806,1274. Real vs Nominal Returns
The return rate should be NOMINAL (not adjusted for inflation). The system calculates REAL purchasing power by comparing nominal portfolio growth against inflation. This approach allows for separate sensitivity analysis of investment performance vs inflation risk.
Real Return ≈ Nominal Return - Inflation Rate
Example: 7% nominal return - 3% inflation = ~4% real purchasing power growth per year5. Withdrawal Impact on Returns
During retirement, portfolio withdrawals reduce the balance available to earn returns. The interaction between return rate, inflation, and withdrawal rate determines the sustainability of income streams from the portfolio. Return rates above the combined withdrawal and inflation rates allow the portfolio to grow in real terms.
Example: $1M portfolio, 7% return, 4% withdrawal ($40k) → Net growth: 3% → portfolio maintains purchasing power
Real-world context
Historical Stock/Bond Returns
1926-2024 data shows US large-cap stocks returning 10.2% annually, small-cap 12.4%, corporate bonds 6.0%, Treasury bonds 5.3%, and T-bills 3.3%. However, these are MARKET returns before fees, taxes, and behavioral costs. Actual investor returns are typically 2-3% lower.
IRS reference: Historical data from Ibbotson SBBI Yearbook
Asset Allocation Rules of Thumb
Conservative planning uses 5-6% for portfolios with 40-60% stocks. Moderate portfolios (60-70% stocks) use 6-7%. Aggressive portfolios (80%+ stocks) use 7-8%. Using returns above 8% is generally overly optimistic and may require larger portfolio balances to support desired retirement income streams.
Sequence of Returns Risk
Two retirees with identical 7% average returns can have vastly different outcomes. Poor returns early in retirement (when withdrawals are largest as % of portfolio) are much more damaging than poor returns later. This is why safe withdrawal rates are conservative (3-4%) despite higher expected returns.
Fee Impact on Returns
A 1% fee difference compounds dramatically over 30 years. $500k with 7% return grows to $3.8M. Same portfolio with 6% return (1% fee drag) grows to only $2.9M - a $900k difference. Index funds (0.05% fees) vs actively managed funds (1%+ fees) have massive long-term impact.
Safe Withdrawal Rate Research
The 4% rule (William Bengen, 1994) assumes 7% nominal returns and 3% inflation (4% real). Trinity Study (1998) confirmed 4% withdrawal rate has 95%+ success over 30 years with 50%+ stock allocation. Lower returns require lower withdrawal rates or higher portfolio balances.
What drives the result
Sets the baseline growth rate for all portfolio projections. Higher returns increase projected retirement portfolio values and may allow higher income withdrawal rates or earlier retirement transitions. Lower returns require larger starting portfolio to generate desired income streams.
6% return: $1M → $1.79M in 10 years | 8% return: $1M → $2.16M in 10 years (+$370k difference)
Percentage of churned gains withheld from taxable accounts to model tax drag from portfolio turnover. Set this to approximate the client's expected capital gains tax rate. Zero withholding assumes taxes are paid from outside the account (invisible tax drag); non-zero withholding makes tax drag visible by reducing account value. See Churn Withholding Rate for full explanation.
0% withholding: taxes paid externally, no account impact | 15% withholding: moderate-income client in 15% LTCG bracket | 20% withholding: high-income client in 20% LTCG bracket
How you allocate assets across account types affects after-tax returns. Tax-inefficient assets (bonds, REITs) should be in tax-deferred accounts. Stocks should be in taxable accounts for preferential capital gains treatment.
Moving $100k bonds from taxable to IRA saves ~$1,500/year in ordinary income tax on interest
Assumptions
- Returns are consistent year-over-year (reality: high volatility, sequence risk)
- No market crashes or prolonged bear markets (reality: periodic 20-50% drawdowns)
- Dividends and interest fully reinvested (not spent)
- Portfolio rebalanced annually to maintain target allocation
- No consideration of tax drag on returns in taxable accounts
- Same return applies to all account types (tax-deferred, tax-free, taxable)
Limitations
- Does not model volatility or sequence of returns risk
- Does not account for varying returns across different account types
- Does not model tactical allocation changes over time
- Does not incorporate periodic contributions or withdrawals mid-year
- Ignores impact of required minimum distributions on portfolio allocation
Related
This page explains how Stratum models this calculation. It is educational material for financial professionals, not tax or legal advice, and tax law changes. Verify current figures against primary IRS sources before relying on them with a client.