Buffett: Don't expect returns over 7% over next century

[cardude]

From his latest letter, posted today:
http://www.berkshirehathaway.com/2007ar/2007ar.pdf

He has made this prediction before, but here he is using it to show how pension return estimates are out of whack at 9%. He only uses the Dow to show his example, but he says you would be crazy to expect returns over 7% (including dividends and after fees of.5) over the next century.

More international tilt anyone? Thoughts? Is anyone expecting way lower than 4% real returns on their overall portfolio?

The average holdings of bonds and cash for all pension funds is about 28%, and on these assets
returns can be expected to be no more than 5%. Higher yields, of course, are obtainable but they carry with
them a risk of commensurate (or greater) loss.

This means that the remaining 72% of assets – which are mostly in equities, either held directly or
through vehicles such as hedge funds or private-equity investments – must earn 9.2% in order for the fund
overall to achieve the postulated 8%. And that return must be delivered after all fees, which are now far
higher than they have ever been.

How realistic is this expectation? Let’s revisit some data I mentioned two years ago: During the
20th Century, the Dow advanced from 66 to 11,497. This gain, though it appears huge, shrinks to 5.3%
when compounded annually. An investor who owned the Dow throughout the century would also have
received generous dividends for much of the period, but only about 2% or so in the final years. It was a
wonderful century.

Think now about this century. For investors to merely match that 5.3% market-value gain, the
Dow – recently below 13,000 – would need to close at about 2,000,000 on December 31, 2099. We are
now eight years into this century, and we have racked up less than 2,000 of the 1,988,000 Dow points the
market needed to travel in this hundred years to equal the 5.3% of the last.

It’s amusing that commentators regularly hyperventilate at the prospect of the Dow crossing an
even number of thousands, such as 14,000 or 15,000. If they keep reacting that way, a 5.3% annual gain
for the century will mean they experience at least 1,986 seizures during the next 92 years. While anything
is possible, does anyone really believe this is the most likely outcome?

Dividends continue to run about 2%. Even if stocks were to average the 5.3% annual appreciation
of the 1900s, the equity portion of plan assets – allowing for expenses of .5% – would produce no more
than 7% or so. And .5% may well understate costs, given the presence of layers of consultants and highpriced
managers (“helpers”).

Naturally, everyone expects to be above average. And those helpers – bless their hearts – will
certainly encourage their clients in this belief. But, as a class, the helper-aided group must be below
average. The reason is simple: 1) Investors, overall, will necessarily earn an average return, minus costs
they incur; 2) Passive and index investors, through their very inactivity, will earn that average minus costs
that are very low; 3) With that group earning average returns, so must the remaining group – the active
investors. But this group will incur high transaction, management, and advisory costs. Therefore, the
active investors will have their returns diminished by a far greater percentage than will their inactive
brethren. That means that the passive group – the “know-nothings” – must win.

I should mention that people who expect to earn 10% annually from equities during this century –
envisioning that 2% of that will come from dividends and 8% from price appreciation – are implicitly
forecasting a level of about 24,000,000 on the Dow by 2100. If your adviser talks to you about doubledigit
returns from equities, explain this math to him – not that it will faze him. Many helpers are apparently
direct descendants of the queen in Alice in Wonderland, who said: “Why, sometimes I’ve believed as many
as six impossible things before breakfast.” Beware the glib helper who fills your head with fantasies while
he fills his pockets with fees.

[Hillbilly]

"Beware the glib helper who fills your head with fantasies while
he fills his pockets with fees. "

This statement by itself should give the index folks lot to cheer over.

Mr Buffett is stating much of what Bogle has been taking about in lower future returns. Another of "the wise guys" saying the same thing...time will tell.

[retire@40]

This is in line with I think as well. That's why in another thread I stated I would be very tempted to sign on to a guaranteed 7.5% rate of return for the rest of my life and I would lock in for sure at 8%.

[Want2retire]

Originally Posted by cardude

Is anyone expecting way lower than 4% real returns on their overall portfolio?

Why expect the rate of real returns to be either above 4% or below 4%? I would rather keep a wide range of possibilities in mind and be ready for a variety of future economic events. Then I can be thinking about how to deal with them as appropriately as I can.

[tightasadrum]

I think I'll hang on to my rental units. It's a little more work than passive investing, but I have more personal control over the outcome, discounting the overall movement in rental markets. The more I study these things, the more I love diversification.

[unclemick]

Hmmm - I find it interesting that Bogle and Buffett fall usually in the same ballpark handgrenade wise when estimating returns going forward - Bogle usually limits himself to decade estimates.

Their method of estimating is different but I seem to recall they were reasonibly close in the 80's and 90's also - even the bubble left them both looking foolish til it popped.

heh heh heh - Then there is Bernstein and his looks at population growth/GDP interaction and Mr Market.

[cute fuzzy bunny]

Do note that a lot of these guys like to hit you with a lowball to reduce your expecations.

Warrens been telling people for years to expect weak returns from the markets and from BRK. Then when he exceeds those reduced expectations, he's a hero.

That having been said, I wouldnt do any planning where expectations of >7% returns without any principal consumption were mandatory.

[al_bundy]

1900 if you would have shown someone a map of Europe of 2000 they would have you locked up in a mental institution. if you would have told someone that in 2000 Britain and the US would be allies in 2000 you would be crazy

[free4now]

While he may very well be correct, the argument about the dow needing to break lots of increments of 1000 is totally specious. I'm sure when the dow was at 66 it was big news every time it passed increments of 10, but that doesn't mean everyone still celebrates such increments today. He's totally aware that's just how logarithmic growth works, so it seems like his argument is designed to appeal to people who don't understand logarithms. I expect better of him.

[bots2019]

Originally Posted by free4now

While he may very well be correct, the argument about the dow needing to break lots of increments of 1000 is totally specious. I'm sure when the dow was at 66 it was big news every time it passed increments of 10, but that doesn't mean everyone still celebrates such increments today. He's totally aware that's just how logarithmic growth works, so it seems like his argument is designed to appeal to people who don't understand logarithms. I expect better of him.

This was exactly my reaction - while his overall point may indeed be correct it seems arbitrary to say "look how high the dow would have to be!". It's very possible that in the year 2100 a $1M salary will be considered subpar! Looking at numbers as absolutes seems a little silly.

[cute fuzzy bunny]

Someone needs to alert CNBC and the rest of their ilk who often have numerous mini-parties on television every time we break a 1,000 mark to the upside or downside that all of this is totally specious.

Until you consider, as Warren obviously has, that investor psychology plays a bit of a role in market movements.

[Notmuchlonger]

If WB is correct 7% returns means the 4% theory wont hold water. Good luck getting inflation to co-operate.

[aenlighten]

but I don't expect to live another century either. World population peaks sometime around midcentury so that can be expected to lower growth. Would you rather live in the future or in the past though? Growth is good, but so are higher living standards. By then we may have gone interplanetary if not interstellar. On the other hand, some things we take for granted now will probably seem like real luxuries in the future.

[Hillbilly]

Originally Posted by cute fuzzy bunny

Someone needs to alert CNBC and the rest of their ilk who often have numerous mini-parties on television every time we break a 1,000 mark to the upside or downside that all of this is totally specious.

Well guess who is on CNBC Monday....Warren himself. Maybe for 3 hours or so. Should be a MEGA-party....(IMHO I'm surprised he shows up). Probably have highlights on ESPN SportsCenter Monday night .

[Texas Proud]

Boy... this one is taxing my memory....

Did HE not say that if he were starting out today HE would expect something like 20% return PER YEAR

Can someone find this

[FIREdreamer]

I was originaly planning on 8% yearly returns, but Morningstar expects a return of only 7.5% for my portfolio going forward. So I now use 7% expected returns for my FIRE calculations. If everyone predicting 7% returns on stocks in the future happened to be on the low side, then I guess I'll FIRE sooner then expected!

Morningstar's expected future annual returns are:
4% on cash
5.5% on bonds
7,6% on US large caps
8.4% on US small caps
8.3% on foreign stocks

[MooreBonds]

Originally Posted by Texas Proud

Boy... this one is taxing my memory....

Did HE not say that if he were starting out today HE would expect something like 20% return PER YEAR

Can someone find this

Well, he was saying that if he wasn't handicapped with a $50 Billion portfolio and only had to find places to invest a few million, he felt confident he could average 50% returns/year, as he saw a lot of opportunities.

There's a big difference between what he's forecasting for the market overall vs what he feels he would be able to produce.

[youbet]

Originally Posted by Notmuchlonger

If WB is correct 7% returns means the 4% theory wont hold water. Good luck getting inflation to co-operate.

Don't forget that the 4% guideline includes consuming principal.

[chinaco]

He is just saying: be realistic. Play it safe, be conservative with your planning. Good advice in my book.

Of course, there is always the risk/reward trade-off. You can take more risk.

[Spanky]

Originally Posted by cute fuzzy bunny

Warrens been telling people for years to expect weak returns from the markets and from BRK. Then when he exceeds those reduced expectations, he's a hero.

We do the same thing at work, telling management that the project will take X months to complete and getting it done in X-4 months.