More Gloom and Doom? Long-term real returns of 2.1%

[samclem]

Yet another gloomy prediction, this time in Brett Arends' column in the WSJ 28 Oct.

The article.
Arends interviews John West and Rob Arnott and others
Highlights:

Quote:

- "We're headed for a retirement train wreck," he adds, "and it's going to get really ugly over the next 15 years." Alarmist? Perhaps. But follow the math. The returns you will get from your stock funds can only come from four things, they note: Dividends, earnings growth, inflation and changes in valuation. Right now the dividend yield on U.S. stocks is about 2.2%, they note. Historically, earnings have only grown by a surprisingly low 1% a year in real, inflation-adjusted terms. Mr. Arnott tells me the average since 1900 is only about 1.2%, and in the last half century just 0.6%. Will we get more in the future? With the U.S. population ageing and heavily in debt? It's hard to imagine. Throw in a 2% inflation forecast–more on this later–and Research Affiliates forecasts a long-term return of 5.2%. What about changes in valuation? . . . The stock market's latest rally has lifted shares already to pretty high levels in relation to average cyclically-adjusted earnings. This so-called "Shiller PE" (named after Yale professor Robert Shiller, who popularized the notion) has been an excellent indicator of market value. Right now it's at about 22–well above its historic average of 16. The only time the market has boomed from these levels, was in the late 1990s bubble–an atypical moment unlikely to be repeated any time soon. Now look at bonds. Thanks to the recent boom, the picture for investors here looks even worse. And there is less room for ambiguity, because bond coupons and the repayment of principal are fixed. Based on the yields of prices across all investment grade bonds, Mr. West and Mr. Arnott calculate likely long-term bond returns from here of about 2.5%. So an investor with 60% of his portfolio in stocks and 40% in bonds, a standard, if conservative, allocation, can expect a weighted average return from here of only about 4.1%. To put this in context, they notice that the typical big pension fund is still expecting to earn about 7% to 8% a year. When you strip out 2% inflation, that means pension fund managers are expecting 5-6% percent a year in real, inflation-adjusted terms. But by Mr. West and Mr. Arnott's numbers, investors can only expect about 2.1%. . . . Bottom line? Neither pension funds nor private investors seem to have fully absorbed the grim lessons of the past decade. Returns are going to be much lower. People need to save more, much more, for their retirement. If the market rally this year has given them false hope, it will have turned out to be a curse more than a blessing.

In the article, Arends also proposes to Arnott that maybe stock buybacks or emerging markets might boost returns, but Arnott shoots down these ideas.

This is forwarded only because I thought it interesting. I've got no insight as to whether these guys know what they are talking about. I hope they are wrong, because if 2-2.5% turns out to be the real SWD going forward, folks in our house will be eating a lot of beans and rice in the coming decades.

[stoutboy]

I agree with him that the pension managers (and most private investors) are making a big mistake in relying on an 8% return like in previous decades.

I don't quite buy his rebuttal of emerging markets. I think there is still a lot of room to grow there. The real permanent adjustment will occur when China and India finish their runs. Thankfully, that won't happen for a couple of more decades at least.

Perhaps the best bet is to just hope you hit it big on a Chinese IPO.

Quote:

Originally Posted by samclem Yet another gloomy prediction, this time in Brett Arends' column in the WSJ 28 Oct. The article. Arends interviews John West and Rob Arnott and others Highlights: In the article, Arends also proposes to Arnott that maybe stock buybacks or emerging markets might boost returns, but Arnott shoots down these ideas. This is forwarded only because I thought it interesting. I've got no insight as to whether these guys know what they are talking about. I hope they are wrong, because if 2-2.5% turns out to be the real SWD going forward, folks in our house will be eating a lot of beans and rice in the coming decades.

[haha]

Quote:

Originally Posted by samclem Yet another gloomy prediction, this time in Brett Arends' column in the WSJ 28 Oct. The article. Arends interviews John West and Rob Arnott and others Highlights: In the article, Arends also proposes to Arnott that maybe stock buybacks or emerging markets might boost returns, but Arnott shoots down these ideas. This is forwarded only because I thought it interesting. I've got no insight as to whether these guys know what they are talking about. I hope they are wrong, because if 2-2.5% turns out to be the real SWD going forward, folks in our house will be eating a lot of beans and rice in the coming decades.

These people absolutely know what they are talking about. Whether they will prove right or wrong in the intermediate term likely depends on how good L'il Ben is at his next bubble blow job.

But if these ideas are bothersome, don't fret- some guy of Yahoo Ticker Talk today was predicting Dow 35,000 or somesuch. So no problem, just keep shopping for a more palatable forecast.

Ha

[NW-Bound]

I have recently decided that I am not going to worry anymore. I may not be filthy rich, but I still have more than many people. And if it gets too tough, I will just take off in my little motor home, and get myself an annual camping pass for $225 in New Mexico. Party on!

[TooFrugal]

I'm not counting on being able to get more than about 2% real return. Anything beyond that will be a plus. But I am also going to do more research on investments in other countries. I just don't see any reason for the U.S. to be on an economic upswing for a long time to come.

[keegs]

RA (Research Affiliates or Rob Arnott ...take your pick) pushes the fundemental indexing strategy claiming it improves returns over capitalization indexing.

So is he just another voice in he crowd trying to get your business?

Don't know but I did some checking on this forum and from what I gather, at least some of you think so.

[RonBoyd]

Quote:

Originally Posted by NW-Bound I have recently decided that I am not going to worry anymore. I may not be filthy rich, but I still have more than many people. And if it gets too tough, I will just take off in my little motor home, and get myself an annual camping pass for $225 in New Mexico. Party on!

+1

[BigNick]

Yet more weight, if it were needed, behind the view that what makes a comfortable retirement (early or not) possible, is /1/ LBYM, /2/ socking away the income that LBYM freed up, and /3/ an early start in order to compound as far as possible whatever growth there is. To me, asset allocation is secondary in terms of hitting numbers goals.

[MichaelB]

Quote:

Originally Posted by haha But if these ideas are bothersome, don't fret- some guy of Yahoo Ticker Talk today was predicting Dow 35,000 or somesuch. So no problem, just keep shopping for a more palatable forecast. Ha

Kind of like what we are going to do next tuesday in the voting booth?

[audreyh1]

Quote:

Originally Posted by NW-Bound I have recently decided that I am not going to worry anymore. I may not be filthy rich, but I still have more than many people. And if it gets too tough, I will just take off in my little motor home, and get myself an annual camping pass for $225 in New Mexico. Party on!

+2

[HFWR]

I'm going to need some more meds...

My crystal ball says not to expect more than 4-5% real, but I have absolutely no analysis to back that up.

[MichaelB]

These projections may be realistic. Nonetheless, they are completely passive (do not consider rebalancing), are US centric, only consider current economic conditions projected into the future, and probably only cover the next 5 to 7 years. Most of us and all institutional investments look to a much longer future.

For someone with a 4% withdrawal rate, 2% real growth means they draw down their portfolio around 15% (real) over the next 7 years. But if that were the beginning of a new bull market, they would be in fine shape.

We are slowly but steadily moving away from problems we cannot easily solve (financial catastrophe) to problems we can (budget). No cause for celebration, but reason to not let pessimism rule the day.

[keegs]

If the train wrecks and no one's on it, does it matter?

[NW-Bound]

Yes, it matters to anyone still standing on the tracks.

[FIRE'd@51]

Quote:

Originally Posted by samclem Historically, earnings have only grown by a surprisingly low 1% a year in real, inflation-adjusted terms. Mr. Arnott tells me the average since 1900 is only about 1.2%, and in the last half century just 0.6%.

I have a problem with the West and Arnott data. They state that from 1959-2009, the real growth of corporate earning was only 0.6%. From the BEA database, nominal GDP was $506.6 billion in 1959 and $14,119 billion in 2009. Over that time period the CPI averaged about 3.9%, which means a 1959 dollar was worth about 13.6 cents in 2009. This means that the GDP in 2009 was 0.136 x 14,119 = 1920 in 1959 dollars.

Thus, over that time period, real GDP grew at ( 1920 / 506.6 ) ^ 0.02 = 1.027 , or 2.7% per year, compounded

Certainly corporate earnings have grown as fast, if not faster than real GDP

This would get us to an expected 4.7% real return on stocks

From 1950-2000, the same calculation yields a real GDP of 3.2%, which would imply an expected real return on stocks of 5.2%

[DblDoc]

Quote:

Originally Posted by NW-Bound I have recently decided that I am not going to worry anymore. I may not be filthy rich, but I still have more than many people. And if it gets too tough, I will just take off in my little motor home, and get myself an annual camping pass for $225 in New Mexico. Party on!

A graduate of the Uncle Mick School of life. You still have to choose a down and out football team to root for .

DD

[W2R]

Quote:

Originally Posted by DblDoc A graduate of the Uncle Mick School of life. You still have to choose a down and out football team to root for . DD

HEY!! The Saints were Superbowl Champions last year. Just because they haven't been doing so well this season (yet) is no reason to call them down and out!

On the other hand, locals are digging their brown bags out of the closet (the brown bags that Saints fans used to wear over their heads out of sheer embarrassment.)

[MasterBlaster]

In One Convienient Place, A Life's Supply of Gloom and Doom

Raddr's Early Retirement and Financial Strategy Board :: View topic - In one convenient place, a life's supply of Doom and Gloom

[audreyh1]

Quote:

Originally Posted by MichaelB These projections may be realistic. Nonetheless, they are completely passive (do not consider rebalancing), are US centric, only consider current economic conditions projected into the future, and probably only cover the next 5 to 7 years. Most of us and all institutional investments look to a much longer future. For someone with a 4% withdrawal rate, 2% real growth means they draw down their portfolio around 15% (real) over the next 7 years. But if that were the beginning of a new bull market, they would be in fine shape. We are slowly but steadily moving away from problems we cannot easily solve (financial catastrophe) to problems we can (budget). No cause for celebration, but reason to not let pessimism rule the day.

This is the most clear-headed post I have read all week.

Thanks!

Audrey

[NW-Bound]

Quote:

Originally Posted by DblDoc A graduate of the Uncle Mick School of life. You still have to choose a down and out football team to root for . DD

Uncle Mick's view of life is actually lot more upbeat than mine. And this may be hard for anyone here to understand, but I have never watched any spectator sport game. I did not even watch the last two, or was it three, Olympic games.

About living in a small RV, Tioga George has published his annual expenses once, and I remember that it was around $24K or $26K. At 2.1% SWR, one needs more than a million buck just for that. And remember that Tioga George is over 65 so has Medicare coverage. He also boondocks so that he does not pay for RV parking. And the last couple of years, he has been living down in Mexico too.

Not to scare anybody, but I was just preparing myself mentally, and was only half-joking about RV'ing in New Mexico. After living in a small motor home for a month on a recent trek, I found that it was not all that bad. Heck, it was even fun. Imagine if I were in the boondocks, I might even read and finish War and Peace.