Expected Returns

[gcgang]

Asset Allocation Website

Above is a link to Research Affiliates (Rob Arnott) outlook for asset class returns for the next decade, and it ain't pretty. Excep for EM stuff, looking at pretty close to 0% real returns.

You could dismiss this as discredited market timing, but that's not what they're doing. Like Gross' New Normal, GMOs Asset Class expected returns, all of these look at where we are now - Now being ultra low interest rates and high equity valuations.

For example, historical bond returns have been around 5%. But you can correlate historical ten year bond returns with what the 10 year rate was at the inception of the 10 year period. Today 10 year TNote is what, about 1.5%?

While historical things like Monte Carlo or Firecalc are meant to stress test our situation, none really use today's valuations as a starting point. US markets really don't have much history that's helpful. Maybe Japan of the last 25 years would be a better comparison.

Hopefully they are really not after me, I'm just paranoid.

 

[Independent]

I don't know about other asset classes. But, I'm pretty sure I can calculate the yield to maturity (based on current market prices) on the bonds I already own. And, I'll agree that isn't pretty.

 

[FIREd]

It's pretty much in line with my general expectation for low returns. As long as real returns remain positive, be it only slightly, my plan should work. But US small caps look really ugly on that graph.

 

[sengsational]

Just as a gut check on these 10 year predictions, I'd like to see the 10 year historical on all of those indexes.

The average across all of the asset class predictions (except cash) is 2.22%.

I wonder what the historical 10 year would look like in comparison to the 2.22%.

I figure the money has to go somewhere, and if those 16 cover the world, then one would expect the average of them all to stay around the same over time. The "right" way to do the calculation would be to do a weighted average based on "market capitalization" of each class. So if US Large holds twice as much value as emerging markets, then the weighting would reflect that. But the average might be interesting anyway.

 

[daylatedollarshort]

We just use 0 - 1% real return in a spreadsheet for retirement planning. If we can do better, cool. If not we won't have to move to a shopping cart under the freeway overpass.

We focus on liability matching strategies:
Matching strategy - Bogleheads

We're really into trying to find ways to cut recurring expenses and increase passive income because we can control those but we cannot control the stock market or the direction of interest rates. Every $1K we save off of retirement expenses not impacting our quality of life is another $50K in potential total retirement costs we won't need to fund.

 

[Rick_Head]

Are they including dividends?

 

[bmcgonig]

Asset Allocation Website

Above is a link to Research Affiliates (Rob Arnott) outlook for asset class returns for the next decade, and it ain't pretty. Excep for EM stuff, looking at pretty close to 0% real returns.

You could dismiss this as discredited market timing, but that's not what they're doing. Like Gross' New Normal, GMOs Asset Class expected returns, all of these look at where we are now - Now being ultra low interest rates and high equity valuations.

For example, historical bond returns have been around 5%. But you can correlate historical ten year bond returns with what the 10 year rate was at the inception of the 10 year period. Today 10 year TNote is what, about 1.5%?

While historical things like Monte Carlo or Firecalc are meant to stress test our situation, none really use today's valuations as a starting point. US markets really don't have much history that's helpful. Maybe Japan of the last 25 years would be a better comparison.

Hopefully they are really not after me, I'm just paranoid.

Well actually Firecalc does use today's stock valuations as a starting point, as they are similar to other periods in history. Just look at the graph of CAPE over the years and you will see similar valuations quite a few times. The low interest rates are virtually unprecedented however, as the only time I can see that they were this low were in 1940 or so. I plan on retiring soon and it doesn't give me a warm feeling either.


http://2.bp.blogspot.com/-R8Ezy3hMjZk/U1kXGbyn2jI/AAAAAAAAH1g/O7AhcFX1DLw/s1600/Cape+New.gif

http://static.seekingalpha.com/uploads/2012/5/2/900850-1335995310473923-Mateo-Blumer_origin.png


Then again if valuations are worth using one can always use European stocks?



http://www.valuewalk.com/wp-content/uploads/2013/11/European-stocks-below-long-term-average.jpg
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[danwhite77]

Hope for the best, prepare for the worst.

 

[big-papa]

Towards the bottom of the webpage are links to documents that show their methodology...

 

[Midpack]

While historical things like Monte Carlo or Firecalc are meant to stress test our situation, none really use today's valuations as a starting point. US markets really don't have much history that's helpful. Maybe Japan of the last 25 years would be a better comparison.

Periods of negative US real returns are indeed built in to FIRECALC and many other deterministic calculators, some longer than 10 years - the Great Depression & 1965-83. So in that sense it's not "different this time" that we know of. S&P 500: Total and Inflation-Adjusted Historical Returns

So are "today's valuations." S&P 500 PE Ratio

For those more concerned with a retirement income downside surprise vs upside , having conservative expectations seems prudent though, and we've been planning on real returns of 0-2%, and a historically low WR since long before the current "outlook."

Interesting OP link and it may well prove reasonably accurate (a correction in the next 10 years seems inevitable) - but that doesn't worry me. I am looking forward to Ferri's annual 30-year asset class projections, closer to the timeframe we're faced with.

 

[Spanky]

Based on their forecast, most of our equity allocation should be in emerging markets and MSCI EAFE.

 

[MichaelB]

Those of us in withdrawal mode should be just as, or even more, concerned with volatility, not return. Peter Bernstein said low returns are the result of high volatility. If that is true we should expect to a great deal of marketplace volatility over the next decade across all asset classes.

 

[petershk]

It's interesting to look back at their 2012 research... My very limited look seemed to indiscate they felt that eps outperformance was unlikely to sustain and that emerging market bonds would outperform mature market bonds.

Well... Being wrong or being too early has a similar portfolio impact.

I think most macro forecasters take the wrong approach. They attempt to increase their precision as opposed to attempting to decrease the margin of error between the range of possible outcomes.

The reason for this is that people (paying customers) like PRECISE numbers no matter how utterly incorrect they are historically (look at the department of energy's track record of predicting energy prices out 1-5 years... Yet policy is determined based on that).

This also results in a "ok, Mr cynical, what's your better system?"

Well... I don't have one. But I'd rather not use one than use one I know has so little predictive validity that I can't make actionable decisions with any more confidence than guessing.

I think ultimately investors have two choices:
1) diversified portfolio held over long time and get whatever returns the economy produces (1%, 5%, 10%, who knows).
2) spend huge amounts of time researching individual businesses and understand them really well so when they are REALLY cheap.. you MIGHT get a huge gain (I.e. like Buffett).

I think small amounts of time doing 2 is gambling... I think anything that tries to predict 1acvurately is astrology.

More and more I realize I'm crappy at the deep evaluation and should just live with whatever the general economy will return over time... Using the past return to hedge my risk by informing my spending.

A huge problem exists because people think that because they need something it must exist. Eldorado, the fountain of youth and turning lead to gold were all badly needed and yet...

You may live in a world where you need 7%, but only get 1%. Wishing for the 1% world to become the 7% world is a dangerous illusion imo.

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[Del Q]

I get more nervous when the experts are overly optimistic.

 

[dallas27]

What's the difference between "expected returns" and "fortune telling?"

Is it gypsy versus ivy league background. My guess is the value is identical.


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[Midpack]

What's the difference between "expected returns" and "fortune telling?"

Is it gypsy versus ivy league background. My guess is the value is identical.

So what do you use to plan?

 

[NW-Bound]

Thanks to big-papa for pointing out the below.

Towards the bottom of the webpage are links to documents that show their methodology...

So, I read their rationale for the low expected return of US stocks, compared to the recent past performance. The gist of it is lower growth, lower yield, and P/E contraction.

For past 1983-2013:
Total Return 8.5% = Yield 2.6% + Growth 2.8% + Valuation Change 3.1%

For future:
Total Return 1% = Yield 2% + Growth 1.4% + Valuation Change (-2.4%)

Their above numbers appear to be real return or inflation adjusted, judging from the quoted past return because the 8.5% would be around 11.4% for the S&P 500 in nominal term for the 31-year period of 1983-2013. Average inflation in that period was indeed 2.9%.

Are they including dividends?

The answer is yes, according to the above.

 

[Totoro]

Peter Bernstein said low returns are the result of high volatility. If that is true we should expect to a great deal of marketplace volatility over the next decade across all asset classes.

How did he arrive at that conclusion?

Low returns to me seem to be only the result of high volatility for those that buy at a peak and sell when low. In other words, high volatility gives bigger return spreads for individual investors.

You have a linky for this idea?

Low volatility can also mean low returns if earnings growth steadily goes down, and the stock market steadily goes down with it ..

 

[RetireAge50]

We are going to get whatever we get.

I am hoping (and expect) about 5% real long term (for 60/40 portfolio).

I could live in fear by going all cash or using very low withdrawals. Forcing worst case on myself.

Or alternatively stay invested and take reasonable withdrawals and be prepared to adjust (withdrawals) downward during bad years.

I'm taking the 2nd approach.

 

[haha]

We are going to get whatever we get.

I am hoping (and expect) about 5% real long term (for 60/40 portfolio).

I could live in fear by going all cash or using very low withdrawals. Forcing worst case on myself.

Or alternatively stay invested and take reasonable withdrawals and be prepared to adjust (withdrawals) downward during bad years.

I'm taking the 2nd approach.

Starting fully invested today in a diversified portfolio, this seems very unlikely unless you have an extremely long investing period and will be adding money regularly to the portfolio.

Ha

 

[Ed_The_Gypsy]

For planning, I am using 6% average ROI for a 50/50 mix of US/international equities of which maybe about 2.5% in the way of dividends.

This year and the following two will be high draw-down years (for back-door IRA tol Roth conversions...if Congress doesn't change the laws on us), but thereafter figuring on taking only 3.5% out of the Roth per annum. Somewhere in there, I might chicken out and convert everything to Wellington. My stock picking (O&G and pipelines) has not fared well in the last few months.

 

[Cobra9777]

My retirement model assumes 4.4% nominal return and 2.6% inflation. So 1.8% real. We survive down to zero real, without adjusting the planned expense profile. The 4.4% uses Ferri's 30-year asset class expectations matched to my portfolio (as best I can), plus a 1.5% haircut across the board. I suspect we'll do much better than that. This system may be only marginally better than staring at tea leaves, but it's a plan, and I make spending decisions every day based on it.

I wouldn't quarrel with a bleak outlook for the next 10 years, based on today's valuations and interest rates. That's consistent with my own completely unscientific gut feel. But my planning horizon is longer than that, so I'll stick with Ferri and longer-term actual history as a planning assumption.

 

[MichaelB]

How did he arrive at that conclusion?

Low returns to me seem to be only the result of high volatility for those that buy at a peak and sell when low. In other words, high volatility gives bigger return spreads for individual investors.

You have a linky for this idea?

Low volatility can also mean low returns if earnings growth steadily goes down, and the stock market steadily goes down with it ..

Peter Bernstein was an expert in financial risk and risk management. What he said about volatility was in an interview with Consuelo Mack on Wealthtrack, Oct 21, 2005

CONSUELO MACK: Now, you've been an early proponent of the theory that stocks and bonds -- stocks, especially, I think -- are going to deliver low returns. After the terrific returns we saw in the 80s and 90s that essentially we're talking about lower returns going forward. How low, and why do you feel that way?

PETER BERNSTEIN: How low? Who knows? Just not high. One thing bothers me about this view, that there's very little opposition to it.

CONSUELO MACK: And it's not going to be with our other two guests either.

PETER BERNSTEIN: And that's dangerous. But it's very hard to make the case that returns will be, say, after inflation, more than 6% to 7%. That's the most optimistic expectation. We start from a point where we've had a very -- a huge bull market in the 1990s, only part of which has been given back. Equities are still valued at historically high prices. Interest rates, I don't have to tell you, are historically low. And so you start from there, and there you are. I think something very important to think about this, that a period of low returns, you think, well, every year maybe we'll have 4%, 5%. It doesn't work that way. Low returns result from high volatility. You have a big year, and then a bad year, and the pattern of low return periods is high volatility, not low volatility. It's a scary time.

The point he makes which is not always appreciated is that annualized average returns can be substantially lower than average annual returns because of high volatility.

 

[Options]

This is why I like ESPlanner. Provides annual speding suggestions in the event of 0 returns (conservative option) in Monte Carlo mode. In Upside, treats stock market like the casino that it is, as if all $ invested in stocks is lost. From there, it provides annual spending suggestions allowing one to specify a range for returns in "safe" assets (i.e., bonds). Personally I went with their recommendation of 2@ return for safe assets (TIPS). In either scenario, it works out for me. I've been playing with that software for a year now, and the more I do, the more I like it.

Agree with above post arguing for reducing expeses as best antidote to low expected returns. Other considerations could include delayying SS to 70, immediate annuity at 70, 75, or 80, among others. Point is, options do exist.

 

[dallas27]

So what do you use to plan?

I use long term historical average, and i assume the future will look like the past, that is growth will continue. If i'm wrong, so what, we will all be screwed.


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