But, Should We Really Expect Lower Returns Going Forward?

[DawgMan]

My 60/40 AA was getting a little out of whack so yesterday I did a little early rebalancing and moved a few chess pieces around between my taxable & tax deferred accounts. Part of that process is to review a few charts, one being the Vanguard Historical Index Risk/Return Chart, and the other being some of Paul Merriman's work since he is a big tables/charts guy. Like many here, I have bought into the belief that I should expect future returns to be much lower due to low yielding bonds and "over priced" stocks. In fact, I have conservatively underwritten a 5% average return going forward for my 60/40 AA... but should I??

As I looked at the 2 sets of numbers (which I realize are not truly apples to apples, but close enough), I noticed the Vanguard 60/40 average annual returns from 1926 - 2019 was slightly better than the previous years chart...

Average annual return 8.77%
Best year (1933) 40.57%
Worst year (1931) –27.58%
Years with a loss 22 of 94

Then, I looked at the simple Merriman 60/40 table (S&P/Bonds) from 2008 - 2020, the same period we had extremely low interest rates and even some bumps up & down, and the average annual returns surprised me...

2008 -21.1
2009 16.3
2010 11.7
2011 4.6
2012 10.5
2013 16.8
2014 9.1
2015 1.4
2016 8.1
2017 13.3
2018 -2.1
2019 21.7
2020 15.1
13 Yr Avg 8.1

We have been talking about low yields killing the bond market for 10+ years and how bond prices have no place to go but up. None the less, bond fund total returns have done their thing as a ballast and provided better (at least I think) overall returns in many years. Are we getting to conservative with our future return expectations? So why, THIS TIME, will it be different??

What say you?

 

[donheff]

Who knows. Like you, I assume low returns which leaves me pleasantly surprised when my portfolio grows. Since I want to leave an estate I have no worries that I am leaving money on the table.

 

[Midpack]

I'm glad I never sold off bonds as they've filled their role admirably over the past 12 years, despite the naysayers recommending we dump bonds since 2009. I haven't sold off any bond funds, but the pitiful returns on cash equivalents has made that easier. That said, bond NAVs have to take a hit sooner or later it seems - too bad we still don't know when.

 

[OldShooter]

Who knows. Like you, I assume low returns which leaves me pleasantly surprised when my portfolio grows. Since I want to leave an estate I have no worries that I am leaving money on the table.

Yes. This. Who knows? No one.

No amount of studying market history will yield reliable predictions for the future.

 

[DawgMan]

Yes. This. Who knows? No one.

No amount of studying market history will yield reliable predictions for the future.

Sure, no one knows, but I would suggest past history is the best we got in predicting future trends, particularly longer term trends of 10+ years. I just found it interesting that many of the same conversations about bond yields/prices, inflation, over priced stock market and how the past average returns were a thing of the past, were going on after 2008, and to my surprise, the average return over those 13 years was not far off the trend since 1926! Just an observation that begged the question.

 

[DawgMan]

Who knows. Like you, I assume low returns which leaves me pleasantly surprised when my portfolio grows. Since I want to leave an estate I have no worries that I am leaving money on the table.

Everyone likes a good (positive) surprise!

While I have underwritten 5% average annual returns going forward, I find that many with the same 60/40 AA are getting even more conservative in their expectations... as low as 4%.

 

[GenXguy]

Lower returns, but even more important, MUCH lower REAL returns (think negative) when factoring in runaway inflation, which we are already seeing skyrocketing, with the worst to come. And actually much worse than the government figures. CDs/savings/MMF are losers, bond funds will be hit when the Fed is forced to increase interest rates due to hyperinflation, and stocks are greatly overvalued and are certain to crash one of these days, like when the Fed starts to tighten things up. There's no where to hide.

 

[OldShooter]

I have always liked this story:

... possibly apocryphal but worthwhile anyway: One day well prior to D-day, the army Met (meteorological) office received a request from SHEAF for a weather forecast on a specific day a couple of months in the future. "Impossible," they said and this was relayed up the chain of command. Back down came the order: "A forecast is required for planning purposes."

 

[DawgMan]

Lower returns, but even more important, MUCH lower real returns (think negative) when factoring runaway inflation, which we are already seeing. And actually much worse than the government figures. There's no where to hide.

Well, this kind of analysis is where things can mucky. I would suggest over longer term trends (say 10 yr+ clips) "returns" which take into inflation are really relative to one's personal inflation. While I agree inflation (whether it's short term or late 1970's inflation) is rearing it's head here quickly, we have also enjoyed an 8% annualized return (using my charts) with very low inflation for the last 13 years. For retirees with paid off houses and low overhead along with a reasonable SWR, I would argue their personal inflation is less impactful to the family of 6 with kids in private school/college and all the expenses which accompany pulling that sled (me 10 years ago).

Again, who knows!

 

[kcowan]

I am sticking to my 6% total portfolio growth and 4% expense growth for the financial plan. I pocket any excess growth for future down years. So far so good.

 

[youbet]

The important thing, or course, is to not use "average" returns. Using, say, a 4% average real returns can lead to very misleading results depending on the sequence of returns. Especially on the inflation side of the equation. Two time periods might each result in 4% average real returns but if one is front end loaded and the other back end loaded, the final results will be very different despite having the same average annual real return.

It always bugs me, but that's the way it works. Planning spreadsheets would be sooooo much simpler if a decade of 4% annual average real returns always meant 4% each year. But that never happens. The years very significantly from one another and the sequence of returns becomes the key factor even if the averages are the same from period to period. It's best to plug in a few scenarios, year by year, each resulting in approximately the average real return you're looking to test and observe the differences between front end loading and back end loading the investment returns and the inflation. Early inflation coupled with late high returns will just kill ya............. Late inflation coupled with early high returns is sweet. Even if both scenarios result in the same averages.

 

[kevink]

Surely planning for lower returns and hoping to be pleasantly surprised is prudent. U.S. stock market valuations are very frothy, the 40 year bond bull market looks to have come to an end, and (arguably much more important) debt levels and dollar debasement due to limitless money printing are also at unprecedented levels.

I often recommend the Portfolios.com site in part because it shows the real (after inflation) historical returns for a slew of portfolios over every time frame - unlike most brokerages that skew optimistic by failing to take inflation into account. I'd be thrilled with 2-4% real return going forward from a diversified portfolio of equities and bonds.

And if U.S. government manipulation of inflation statistics to disguise the reality is a reason to be a bit cynical (and I do think it is) I think it's good to remind ourselves that brilliant innovations and discoveries can still lead to growth far surpassing expectations, and that'll be reflected in the stock market. Just look at what's happened with COVID vaccine development and distribution or changes in the electric vehicle market in the past few months.

 

[youbet]

Surely planning for lower returns and hoping to be pleasantly surprised is prudent.

But here on the FIRE Forum, that's only the beginning of being prudent. Most folks seem to assume:

1. Long, long life spans.
2. Expenses greatly exceeding your personal historical data.
3. Non-investment sources of income (SS, pensions, etc.) all crashing.
4. Black swan events occurring repeatedly over your retirement.
5. Lower real returns than ever occurred historically.
6. And on and on. The list is endless.

Can't be too careful ya know...........

 

[Spanky]

But here on the FIRE Forum, that's only the beginning of being prudent. Most folks seem to assume:

1. Long, long life spans.
2. Expenses greatly exceeding your personal historical data.
3. Non-investment sources of income (SS, pensions, etc.) all crashing.
4. Black swan events occurring repeatedly over your retirement.
5. Lower real returns than ever occurred historically.
6. And on and on. The list is endless.

Can't be too careful ya know...........

These assumptions are valid except #1.

 

[USGrant1962]

But here on the FIRE Forum, that's only the beginning of being prudent. Most folks seem to assume:

1. Long, long life spans.
2. Expenses greatly exceeding your personal historical data.
3. Non-investment sources of income (SS, pensions, etc.) all crashing.
4. Black swan events occurring repeatedly over your retirement.
5. Lower real returns than ever occurred historically.
6. And on and on. The list is endless.

Can't be too careful ya know...........

+1

Almost anti-ER in many cases.

 

[Montecfo]

Bond *yields* have no place to go but up. Prices have no place to go but down, and this has happened already early in this recovery cycle.

Secular bull markets historically have begun from much lower valuations than the near record high valuations we are experiencing now.

We also have record deficit government spending and possibly more on the way. Potentially inflationary.

So prudently, I plan for reduced equity returns over the mid to longer term. I also expect higher interest rates and poor returns for anything but very short duration bonds (junk bonds I view as equities).

I could be pleasantly surprised about equities if stocks can continue to grow into their valuations. We are off to a good start in that regard.

Bond yields are not sufficient to entice me to take a risk on duration. But I do not expect a huge rise, but any rise is material with rates so low ( as we have seen over the past 9 months or so).

 

[NW-Bound]

But here on the FIRE Forum, that's only the beginning of being prudent. Most folks seem to assume:

1. Long, long life spans.
2. Expenses greatly exceeding your personal historical data.
3. Non-investment sources of income (SS, pensions, etc.) all crashing.
4. Black swan events occurring repeatedly over your retirement.
5. Lower real returns than ever occurred historically.
6. And on and on. The list is endless.

Can't be too careful ya know...........

These assumptions are valid except #1.

+1

That most important item #1 there, when negated, overrides all the remaining items. It did happen to some popular posters we knew.

So, we cannot worry too much about 2 to 6.


PS. I myself almost could not make it to the early SS age of 62. So now, me worry?

 

[youbet]

+1



PS. I myself almost could not make it to the early SS age of 62. So now, me worry?

But ya did....... And we're glad!

 

[NW-Bound]

But ya did....... And we're glad!

Thanks. Me too.

And that's why I have not felt the need to blow the dough, even though I can spend a whole lot more. Just being alive, not in pain, and having full mobility is wonderful enough.

But if you are talking about money, I still want to see my stash grow. It's a challenge, just the same as I spend a lot of time tweaking my DIY solar system to reduce my electric bill a bit more, even though it is not really the savings that drives my effort.

 

[audreyh1]

Yeah, I plan for lower returns. I just hope they aren’t negative!

 

[braumeister]

Ever since I started making projections about my future finances, a long time ago, I've always used an estimated 2% real (over inflation) return. That has turned out to be very conservative.

 

[24601NoMore]

I'm of the opinion that the next decade will be nothing at all like the previous one.

US stocks by all measures are at least 2X over-valued. Bonds are of course being pressured by rising rates. And cash is near zero nominal and returning negative real. Aside from that, it's all good

Sure, the equities party might continue..for a while. But at some point (likely quite soon, IMHO), the appetite for risk is going to change - and when it does, it's not likely to be pretty (as in, 50+% drawdown, or as advisors often say "asset repricing" to revert to mean valuations).

Here's a really good article with some excellent historical perspective and very well-reasoned analysis on likely near term outcomes. While "no-one knows nuttin", the signs are blazing thermonuclear neon for any of us who are looking at things objectively and in terms of traditional market valuations.

https://www.advisorperspectives.com/articles/2021/04/26/the-stock-markets-collapse-is-near

An interesting and relevant excerpt nets out just how bad things could get in the next decade or two..

The long timeframe of this chart belies just how hard the bad periods were. Period 3, the Great Depression and WWII, lasted 19.8 years with no real return (-0.5% annualized) and a paltry nominal return of 1.2% annualized. In those 20 years, there were three serious drawdowns; -79%, -50%, and -49%. Period 5, the 1960s and 1970s, lasted 16.3 years and lost 1.7% annualized real return. There were four major drawdowns; -18%, -36%, -52%, and -27%. Period 7, the dot-com and housing bubbles, was shorter at 8.5 years but lost 8.8% annualized real and had two major drawdowns: -47% and –52%. Despite these drawdowns eventually being recovered, they were severe enough to tempt selling at the wrong time and not experiencing the recovery.

Not to be a negative nelly, but I do truly believe the days of 8+% or even 5+% returns are long behind us for at least the next decade if not longer. Much more likely is a period where those of us in ER need to focus on capital preservation vs capital growth. YMMV, but JMHO.

Personally, I'm liking Gold and Inflation Protection assets..and foreign markets with much lower P/Es than the US. Especially foreign value and Asia Pac. And in Fixed Income, Floating Rate funds..sure..I'm not going to beat those investing in TSLA, AMZN, Bitcoin, etc..but my primary goal is to avoid the 50+% downdraft that I strongly believe is likely in 2021 or early 2022 at latest, not to outperform my neighbor investing in the latest hot stocks, crypto or funds..

 

[Fermion]

Stocks are not overvalued 2x if inflation gets to 100% over the next decade. That is only something like 7% per year.

 

[audreyh1]

After 20 years in retirement I just take it year by year. Our investment strategy hasn't changed. Our portfolio has really grown. Meanwhile we get older each year......

When our net worth keeps up with inflation, I feel like I've won the lottery!!!!

 

[24601NoMore]

Stocks are not overvalued 2x if inflation gets to 100% over the next decade. That is only something like 7% per year.

Not sure I follow. Inflation causes increases in company costs (labor, materials), which reduces EPS. If stock prices were to remain constant OR rise in that scenario, P/E ratios would become even further stretched than they already are. And by all measures - CAPE 10, Buffet ratio and many others, we're sitting at least at 2X+ "normal" at these levels.

Curious to hear more on how inflationary pressures are good for stock valuations, especially compared to historical levels. Maybe I'm just missing something..