- "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.
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