Opinion – From Grain to Grain: How to define the target rate of return in your plan for independence?

Estimating the future return on your portfolio is critical in building a plan for financial independence. Two estimates are necessary: ​​one for the period of constitution of financial assets and another for the period of receipt of income. In this task, a mistake can be costly. Then, I explain how to mitigate this risk.

The estimation of rates of return seems very easy. But this facility hides risks.

There are two risks to this estimation. If you estimate a very high rate of return in the accumulation period, but it is not feasible, you will not reach the desired equity or it will take longer than expected to reach it.

The other risk is overestimating the rate of return over the period of receipt of portfolio income. If the effective rate in the period is lower than estimated, then your income will be lower than programmed.

In both cases, realize that risk exists if you err on the upside in estimating returns.

So be conservative.

Be careful not to extrapolate the higher interest and dividend rates we are experiencing.

It will be easier to reach the desired equity if you extrapolate the current real interest rates of IPCA+6%, but it is not possible to guarantee the investment at the same rate in five years.

As the usufruct period of the income from the assets to be constituted is more distant, the ideal is to be even more conservative in this case.

There are two ways to estimate the return.

The first would be to use a long-term average of the target portfolio’s past return, for example over the last ten years. This target portfolio could be built from the investor profile.

This portfolio could have a diversification of investments such as public and private fixed-income securities, national and international stock indices, real estate funds and others.

However, this procedure is not the simplest.

The most recommended thing would be to estimate a multiple over real rates, that is, above inflation, on federal public bonds. As I mentioned, the ideal is to consider a past average of these rates and not the current ones.

For example, you might estimate that a conservative investor would earn a real return of at least 4.5% per year over the next twenty years. This first period would be the accumulation of assets. In the final period of enjoyment of the benefit, it could use 4% per year as a return.

For a slightly more moderate profile, a multiple of 110% of these rates could be considered, that is, approximately 5% per year in the first period and 4.5% per year in the second period. This multiple can be even higher the bolder your profile is. However, you must pay attention to limits.

It is unlikely to sustainably achieve long-term returns of 200% of government bond rates.

Also, don’t make the mistake of using the return that has been earned by a successful person on investments. This return can be very difficult to repeat.

Be careful not to fall into the trap of believing that because Luiz Barsi or Warren Buffet did it, you can easily do it. After all, how many Barsis and Buffets do you know?

Defining these target returns is very important as your guide to portfolio valuation. They, too, must be reviewed periodically to verify that they are reasonable within the reality at each time.

Michael Viriato is an investment advisor and founding partner of Investor House.

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Book: The Journey to Financial Independence

summary

Introduction
Understand how you will achieve your financial independence
Living on an income is the last step on the journey to financial independence
These are the biggest questions about the journey to independence

Chapter 1 Construction of the plan
The first step in building the blueprint for financial independence
How to define the rate of return in your plan for independence?