By Dr. James M. Dahle, WCI Founder
A question:
“I read some projections that showed the returns of stocks and bonds would be very low over the next decade. What should I do differently with my investments because of that?”
Every year, there are several papers published that project future returns. The most recent paper from investing behemoth Vanguard estimated annualized, nominal (before inflation) returns of just 3.3% for US stocks, 2.9% for US Real Estate Investment Trusts (REITs), 6.2% for international stocks, and 1.9% for US bonds.
The first thing to know about these papers is that they are often wrong. For example, over the last decade, many of these papers have called for much lower returns than what markets have actually experienced. It turns out that everybody’s crystal ball is cloudy, not just yours. While valuations, such as price-to-earnings ratios and bond yields, do matter, they are pretty lousy predictors of future returns, especially in the short term.
These projections also tend to be on the pessimistic side for an obvious reason. As an investment professional making projections, if markets do better than your projections, none of your clients are mad at you. But if you call for high returns and they don’t show up, the clients all take their business elsewhere. So, take any future expected return projections with a grain of salt.
These projections are also overly precise. They are reported to one-tenth of a percentage point, but there is an extremely good chance they don’t have the first number right, much less the second. In reality, any projection that is not a range is improperly precise. While that precision makes the projectors look smart, it is inappropriate given the difficulty of the task. Unfortunately, a proper projection would have such a wide range as to be almost useless.
However, I actually agree with the projectionists that investment returns over the next decade are likely to be significantly lower than those over the last decade. This occurrence would have significant consequences on your financial life. What should you do about it? Several things.
#1 Reduce the Bite of Taxes, Fees, and Inflation
The only return that matters is your after-tax, after-fee, after-inflation return. Reduce your investment-related taxes by maximizing the use of tax-protected retirement accounts, like 401(k)s, Roth IRAs, Health Savings Accounts (HSAs), and 529s. Avoid short-term, rapid-fire trading so you can take advantage of lower long-term capital gains and qualified dividend tax rates. Watch your investment commissions and advisory fees. Every dollar you pay to someone else is a dollar that comes out of your investment return. You also want a significant portion of your portfolio invested into assets that tend to keep up with or beat inflation in the long run, such as stocks, real estate, and inflation-indexed bonds.
#2 Stay the Course
Following a written investing plan through thick and thin is a key to successful long-term investing. Chasing performance by jumping from one type of investment (asset class) to another leads to higher costs and lower returns, as the investor repeatedly buys high and sells low. As a general rule, in a low-interest rate and low-expected return environment, all asset classes are affected more or less equally. While bond yields are particularly easy to see, the truth is that when bond yields (and, thus, future bond returns) are lower than historical averages, so are the returns of everything else, including stocks, real estate, and speculative investments. Expecting low-bond yields due to low-interest rates while also expecting historical stock returns is a classic error.
More information here:
Beaten Down by the Bear Market? Now’s the Time to Stay Strong (and to Stay the Course)
#3 Do Not Fear Rising Interest Rates
Investors, particularly bond investors, have an inappropriate fear of rising interest rates. While rising interest rates do decrease the value of bonds (as well as stocks), this is only a short-term effect. In the long run, a bond investor does better with higher interest rates, so long as the investor’s investment horizon is longer than the duration (a measure related to the maturity length) of the bonds. All else being equal, higher interest rates are better for savers and investors (although worse for future debtors).
#4 Diversify
Recognize that just about every asset class will have its day in the sun. That is not an invitation to jump from asset class to asset class, chasing performance. Instead, make sure you own several asset classes in your portfolio. Diversification is key. The Vanguard projections suggest higher future returns for international, small, and value stocks than for the US, large, and growth stocks that have outperformed in the last decade. Make sure your portfolio includes some of those asset classes.
More information here:
The 6 Stages of Diversification — Where Are You At?
#5 Be Philosophical
Rather than being depressed that future returns are likely to be lower, try to be a bit more philosophical. Recognize that if past returns had not been so high (leaving more room for future growth), your nest egg would be much smaller. Higher returns on a smaller nest egg are not all that different from lower returns on a larger nest egg for most investors, although very old and very young investors will obviously prefer opposite ends of that spectrum.
#6 Save More
You cannot control future returns. You might as well accept the returns the market gives you and spend your effort controlling that which is within your control, such as your lifestyle and, thus, your savings rate. If future returns are really lower, then you will need to save more money to reach your goals. Future returns, especially after-inflation returns, are likely to be lower than in recent decades. You should still follow your reasonable, written investing plan. If you do not yet have one, develop one, either with or without the assistance of a capable financial planner.
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Are you worried about lower returns over the next decade? What are you doing to mitigate that? What is your crystal ball telling you? Comment below!
[This article was originally published at ACEPNow.]
I try to reassure myself that over a long time period, hopefully my investments outpace inflation comfortably, even if for 10+ years they don’t.
What is concerning though is the performance of investments with a fixed(-ish) time horizon – specifically 529. I am finding it very hard to know what to do about investing within 529s that will need to start paying out over the next 4-11 years.
I have disagreed with WCI over 529s but what I have done is let them ride until a year or two before they’re needed. I’ve been fortunate that those times were not bear markets and I locked in a lot of tax free growth. At that point, I’ve transferred into money market funds so taking risk off the table. I got 15-16 years of growth so no reason to risk it with a downturn right before the money is needed.
4-11 years is quite a spread (22 – 61% of the saving duration).
I think the answer lies in your ability to fund college (to the level you want) if the fund is cut in half right before they go to college. If that is inconvenient, but doable, then I lean towards leaving it more invested in stocks. If that is a catastrophic disaster, then 2-4 years prior to needing it, move most or all of it into bonds or money market accounts (slowly transition it using a plan is even better). Most folks are probably in the middle somewhere.
I kept it mostly in stocks and if it turned out the market tanked right before, I would have cash flowed the first year (or two) and used the 529 to pay for the remaining years while the 529 (hopefully) bounced back. As it turned out, the market cooperated with us. All luck and no help from my crystal ball.
Thanks for the insights Scott. I think we could handle (at least a significant portion of) college payments without tapping the 529 if things were bad in the 529 account at that time. But this would leave unused 529 funds. Aside from redirecting those to someone else (grandkids?!) when they (hopefully) eventually recovered in value in the future, I believe the only other option is to take a 10% withdrawal hit?
You also have until the end of the year to take the money out. Many bear markets are shorter than a year.
Yes true thanks Jim. But I think on the multi-year scenarios that are in play on this point, a slight uptick at the last moment isn’t really anything other than fortuitousness. Not really something that would influence decision making ahead of time.
To quote Ben Carlson: “What jumps out is that there’s no discernible pattern among previous peaks. The stock market has experienced bear markets with high valuations and low valuations, high bond yields and low bond yields, high dividend yields and low dividend yields, high inflation, and low inflation.” Ben Carlson 2017
The lack of predictability of future market performance is what drives me to seek investments that can guarantee high returns and low risk, regardless of the market environment. However, I have found such opportunities difficult to identify. In the mean time I’m choosing diversified low cost investments that provide a reasonable expected return for the level of risk involved.
love the classic Jim! in my financial plan I have used a real return of 5% until I retire in 24 years where my asset allocation for the next 20 years is 65% total US, 25% total international, and 10$ small cap value, and then transition to 60/40 over the 4 years before my retirement. Would that 5% real return be a nice conservative assumption to use given returns going forward may not be as rosy in the past?
also, would you guys predict that the factor premiums also will not be as rosy going forward?
Here’s to cloudy crystal balls!
No idea.
“The Vanguard projections suggest higher future returns for international, small, and value stocks than for the US, large, and growth stocks that have outperformed in the last decade. Make sure your portfolio includes some of those asset classes.”
So… macro crystal balls may indeed be a bit less cloudy than micro (precise return percentages) ones. Seems reasonable. What would you say to someone emphasizing macro trends that project good returns for those investing in various lithium refinement companies and EV companies? Some also mention mRNA companies but as everyone should now clearly see, the healthcare sector is likely going to be increasingly regulated with caps on profit becoming more common as time goes on (macro crystal ball).
Lots of sector risk there. I generally don’t run sector risk as I feel it is uncompensated risk. If you want to make a small bet/tilt there I think that’s fine, but keep it limited.
Buy and hold investors are going to get crushed in the next decade. The demographic boom with boomers and older running the corrupt, centrally planned markets have finally come to a close. The 40 year bull in bonds is done. Get real assets, and if you are in equities, at least get commodity related ones.
Dahle and Bernie are fortunate they made some loot already, because this ship is sinkin’.
If you’re going to make predictions about the future, at least make them specific enough that they can be proven wrong instead of just vague fear-mongering statements.
No problem. If you aren’t at least in commodities for the next 10 years, possibly 12-15, you will lose purchasing power significantly in stocks, and definitely in bonds (you will not be anywhere near keeping up with inflation). Because of this reality, the attempts at higher taxes and tracking via CBDCs will come aboard … if not greater societal disruption within 6-7 years. This may be location dependent to a degree, but either way it’ll affect a large portion of the existing “developed” economies.
Soon the increase in mortality from the experimental mRNA technology will be admitted; it is already obvious to those who are truth seekers and paying attention. I’ll be conservative here since I’m making very bold statements. The combination of health, food and war issues in the next 10 years will decrease the world population by at least 25%.
You have an interesting world view. I hope you’re wrong, if for no other reason than the $2 billion+ people that will soon be dead.
What specific commodities should we purchase? Tin foil for hats?
Things that are unexpected, never happen, right Hank? Like lockdowns and complete freedom loss for something that doesn’t even work? Or firing people for the same thing that is meaningless and injurious? Or calling biological men, women, and vice versa in the field of “medicine.”
Go unprepared Hank, be my guest. Name calling has been so effective in preparing, don’t you know?
Just commenting here so I can bookmark it in my browser. I’ll be coming back here to visit in a few years to see how this prediction panned out. I did the same with some bitcoin lunatic in a different thread, and he never showed up again to defend his viewpoint (that is currently not going so well).
And what will you do if the prediction(s) are closer to reality than not? I’ve made bold calls before and have been right, and I found that the people who always snickered or sighed and were all cynical just hated you more that you ended up being able to call a reality that they can’t see, or synthesize useful information out of an uncertain world. Of course, not every prediction comes to fruition, but the point is that when you make the big calls, you deserve the big credit, and minor predictions that don’t come true are just that … minor. Sorta like losing small bits in the stock market but making big calls that turn out to carry you no matter what happens with the rest.
“And what will you do if the prediction(s) are closer to reality than not?”
Adapt.
Americans are a bit naiive. They do not figure they are in the best country /system/economy so far. If they ever live in China, russia or india for a while , they will become more mature.
Those of us who know our history know the outside world as well, and we know that the traitors among us that encourage what makes the other countries less than ideal are what is currently destroying us. The enemies from within now actively perpetrate hatred of our own culture, history and land, such that we can’t be honest about what actually made us great and gave the legacy. It’s sad that this woke nonsense and lies is the spirit of the age, both here and abroad.
Agree with #6. MOOOOAAAAAAARRRRRRR.
If things tank and returns are lower for the next few years (or negative for an extended period of time), then work more and buy more. Build your wealth now!
You have to buy the right things, though, Napolean. New paradigm coming. See above.
I was purposefully vague with my comment. Investing more in down times usually ends up a good thing. I did not specify what to invest in. Some things will definitely do better than others, but a rising tide floats all boats (that aren’t leaking ;))