June 2, 2008
John Bogle Speech
"As we look ahead, I must mention my conviction that viewing the future through the prism of
history is nowhere near as useful as the prism that takes into account the sources of stock returns. Of what
use, for example, is history that reflects a dividend yield that averaged 5 percent as in the past
century when the current dividend yield is 2.3 percent, less than half as much? (This point might be even more obvious if we asked the relevance of, say, an historical bond yield of 6 percent when the present yield is 4 ¾ percent.) So I urge those of you who rely on Monte Carlo simulations that rely only on historical stock returns either to exchange them for the kind of source-based analysis we’ve just gone through; or, alternatively, to calculate those Monte Carlo simulations using market returns excluding dividend yields, and then add back today’s far lower dividend yield.
Relying on these unarguable sources of return, let’s now consider what returns we might expect
for stocks in the coming decade, starting from this very day.
We’ll begin with investment return. We know that today’s dividend yield on stocks is about 2.3
percent, less than one-half of the historic norm of 5 percent. What should we add in the way of potential
earnings growth for our publicly-held corporations? For reference, the long-term norm has been about 4.5
percent, though in the past 25 years it’s been more than 6 percent.
So let’s add 5 ½ percent earnings growth rate to the divided yield of 2.3
percent. Result: your rational expectations are for an investment return on stocks of about 7.8 percent,
more or less, in the coming decade.
The P/E that I’ll use for today is 18 times, based on the reported earnings of the S&P 500 over the past
twelve months. (I should note that the P/E would be 16 times if we use projected operating earnings, but
we’ll work with the 18 number.)
If we use a central number of 17 times for the 2018 P/E, speculative return would subtract almost a percentage point from your, 7.8
percent investment return. Result: the clear consensus of you professional financial planners is that stock
returns will likely average about 7.2 percent in the decade ahead.
Indeed my own expectations are for earnings growth of about 6 percent, bringing investment return to
about 8.3 percent. I believe that 16 times is a reasonable expectation for the P/E a decade hence, resulting
in a speculative return of more than -1 percent. Result: total return of 7.1 percent. (Chart 9) So, for the
sake of simplicity, let’s agree on a compromise figure of 7 percent per year as the most likely return on
stocks over the coming decade.
A return of 7 percent per year on U.S. stocks is well below the historical norm of 9.6 percent. But
that shouldn’t be surprising. After all, the current dividend yield of 2.3 percent is more than three full
percentage points less than the long-term norm of 5 percent a dead-weight drag on the future investment
returns that stocks can generate, and the P/E today is well above the long term norm of 15 times. Our
rational, and mutual, expectations simply reflect that change in the simple realities of investing.
So make your own individual forecast: Just add your own earnings growth estimate to today’s 2.3 percent dividend
yield, and calculate the investment return. Then calculate the speculative return by taking a guess at the
prevailing P/E multiple ten years hence. Annualize the change, and then combine the two. But never
forget that it's unwise in the extreme to forecast stock returns based on historical norms rather than on
evaluating the broad forces that have shaped them in the past and will continue to shape them in the
future.
But whatever returns the stock market is generous enough to deliver in the years ahead, please
don't make the mistake of thinking that those pre-inflation, pre-investment-cost figures have anything to
do with reality. In real terms, and after the costs of investing, investors will actually earn returns that are
far lower.
To explain why this is the case, we need only to understand these simple mathematics of
investing:
1. Inflation will almost certainly erode the nominal returns we’ve just calculated. Assuming that
inflation averages 2 ½ percent per year (as expected today), the nominal return on stocks of 7
percent over the coming decade would be reduced to 4 ½ percent. (Chart 10A)
2. All investors as a group must necessarily earn precisely the market’s real return, but only
before the costs of investing are deducted. So if equity funds, on average, incur costs of only
2 percent per year, a conservative figure in the light of combined fund costs fund expense
ratios, sales loads, and turnover costs their average annual net real return would be just 2 ½
percent. (Chart 10B)
3. While equity funds themselves, as a group, are all too likely to deliver that net real return of 2
½ percent, the dollar-weighted returns of fund investors have lagged the time-weighted
returns of the funds themselves typically by at least 2 additional percentage points per year.
(Investors appear to chase past performance, and are penalized both by counterproductive
market timing and adverse fund selection.)
If this pattern continues and I see no reason that it will not continue the average equity fund investor could earn a net real return of as little as ½ percent per year over the coming decade. (Chart 10C)
Of course, our expectations for stock returns may be too low. On the other hand, I have ignored
the impact of excess taxes forced on taxable fund investors by our hyperactive fund managers. While we
have no ability to control the level of returns our businesses and our stock markets are generous
enough to generate in the years ahead, we ought to be thinking about controlling what we can control,
including investor costs and investment risks. (These same cautions, of course, apply to thinking about
future bond returns. Since decade-long bond returns are established largely by today’s interest rates, we
can forecast the nominal return on a portfolio of intermediate-term U.S. government and corporate bondsat about 4 ¾ percent, or about 2 ¼ percent after inflation but before all-in bond fund costs of 1½ to 2percent.)"
John Bogle Speech
"As we look ahead, I must mention my conviction that viewing the future through the prism of
history is nowhere near as useful as the prism that takes into account the sources of stock returns. Of what
use, for example, is history that reflects a dividend yield that averaged 5 percent as in the past
century when the current dividend yield is 2.3 percent, less than half as much? (This point might be even more obvious if we asked the relevance of, say, an historical bond yield of 6 percent when the present yield is 4 ¾ percent.) So I urge those of you who rely on Monte Carlo simulations that rely only on historical stock returns either to exchange them for the kind of source-based analysis we’ve just gone through; or, alternatively, to calculate those Monte Carlo simulations using market returns excluding dividend yields, and then add back today’s far lower dividend yield.
Relying on these unarguable sources of return, let’s now consider what returns we might expect
for stocks in the coming decade, starting from this very day.
We’ll begin with investment return. We know that today’s dividend yield on stocks is about 2.3
percent, less than one-half of the historic norm of 5 percent. What should we add in the way of potential
earnings growth for our publicly-held corporations? For reference, the long-term norm has been about 4.5
percent, though in the past 25 years it’s been more than 6 percent.
So let’s add 5 ½ percent earnings growth rate to the divided yield of 2.3
percent. Result: your rational expectations are for an investment return on stocks of about 7.8 percent,
more or less, in the coming decade.
The P/E that I’ll use for today is 18 times, based on the reported earnings of the S&P 500 over the past
twelve months. (I should note that the P/E would be 16 times if we use projected operating earnings, but
we’ll work with the 18 number.)
If we use a central number of 17 times for the 2018 P/E, speculative return would subtract almost a percentage point from your, 7.8
percent investment return. Result: the clear consensus of you professional financial planners is that stock
returns will likely average about 7.2 percent in the decade ahead.
Indeed my own expectations are for earnings growth of about 6 percent, bringing investment return to
about 8.3 percent. I believe that 16 times is a reasonable expectation for the P/E a decade hence, resulting
in a speculative return of more than -1 percent. Result: total return of 7.1 percent. (Chart 9) So, for the
sake of simplicity, let’s agree on a compromise figure of 7 percent per year as the most likely return on
stocks over the coming decade.
A return of 7 percent per year on U.S. stocks is well below the historical norm of 9.6 percent. But
that shouldn’t be surprising. After all, the current dividend yield of 2.3 percent is more than three full
percentage points less than the long-term norm of 5 percent a dead-weight drag on the future investment
returns that stocks can generate, and the P/E today is well above the long term norm of 15 times. Our
rational, and mutual, expectations simply reflect that change in the simple realities of investing.
So make your own individual forecast: Just add your own earnings growth estimate to today’s 2.3 percent dividend
yield, and calculate the investment return. Then calculate the speculative return by taking a guess at the
prevailing P/E multiple ten years hence. Annualize the change, and then combine the two. But never
forget that it's unwise in the extreme to forecast stock returns based on historical norms rather than on
evaluating the broad forces that have shaped them in the past and will continue to shape them in the
future.
But whatever returns the stock market is generous enough to deliver in the years ahead, please
don't make the mistake of thinking that those pre-inflation, pre-investment-cost figures have anything to
do with reality. In real terms, and after the costs of investing, investors will actually earn returns that are
far lower.
To explain why this is the case, we need only to understand these simple mathematics of
investing:
1. Inflation will almost certainly erode the nominal returns we’ve just calculated. Assuming that
inflation averages 2 ½ percent per year (as expected today), the nominal return on stocks of 7
percent over the coming decade would be reduced to 4 ½ percent. (Chart 10A)
2. All investors as a group must necessarily earn precisely the market’s real return, but only
before the costs of investing are deducted. So if equity funds, on average, incur costs of only
2 percent per year, a conservative figure in the light of combined fund costs fund expense
ratios, sales loads, and turnover costs their average annual net real return would be just 2 ½
percent. (Chart 10B)
3. While equity funds themselves, as a group, are all too likely to deliver that net real return of 2
½ percent, the dollar-weighted returns of fund investors have lagged the time-weighted
returns of the funds themselves typically by at least 2 additional percentage points per year.
(Investors appear to chase past performance, and are penalized both by counterproductive
market timing and adverse fund selection.)
If this pattern continues and I see no reason that it will not continue the average equity fund investor could earn a net real return of as little as ½ percent per year over the coming decade. (Chart 10C)
Of course, our expectations for stock returns may be too low. On the other hand, I have ignored
the impact of excess taxes forced on taxable fund investors by our hyperactive fund managers. While we
have no ability to control the level of returns our businesses and our stock markets are generous
enough to generate in the years ahead, we ought to be thinking about controlling what we can control,
including investor costs and investment risks. (These same cautions, of course, apply to thinking about
future bond returns. Since decade-long bond returns are established largely by today’s interest rates, we
can forecast the nominal return on a portfolio of intermediate-term U.S. government and corporate bondsat about 4 ¾ percent, or about 2 ¼ percent after inflation but before all-in bond fund costs of 1½ to 2percent.)"
