How to Invest Your Money » ETFs

Will Future Returns Suck?

Last week, CFB staff writer Robb Engen entertained and enlightened us all with a post on retirement, and specifically how young people should focus on making good financial decisions rather than spending all their time thinking about retirement. This is a good article that’s worth a few minutes of your time if you haven’t already read it. Oh, you have? Fine then, moving on.
Robb makes some assumptions in his post about future stock market returns. I’ll let him explain further:

Investment returns are expected to be lower in the long term.  No longer do we see projections of 12-15% returns.

He goes on to predict a 6% return will be the norm going forward.
I’m curious as to why this is. Robb is echoing (ha, see what I did there?) the sentiment of many different investment professionals. The Euro zone is crumbling! Greece is a mess! The United States is printing money like crazy! Commodity prices are close to record highs! The world is ending! I’m running out of exclamation points! No wonder most of the investment community is calling for lower returns going forward. The future doesn’t exactly look rosy, that’s for sure.

Before we get too excited about all this, let’s take a look at S&P 500 performance over a few selected periods of time, data taken from Money Chimp:

1871-20108.92%
1929-20109.18%
1946-201010.66%
1987-20088.67%
1980-201011.39%

I’m sure some of the more astute readers can figure out why I picked the dates I did. The dates I picked are the years of some of the greatest economic disasters of the past 100 years. Stock markets famously crashed in both the 1929 stock market crash and then again in 1987. The American economy suffered from high unemployment and a crippling national debt after World War 2. (Sound familiar?) Inflation was a horrible problem in the early 1980s. The point is, the market has always found a way to bounce back from adversity. Why wouldn’t it do it again?
Yes, I realize the American economy has all sorts of problems right now. Their deficit is out of control and needs to be reigned in. That much is obvious. I’m going to go out on a limb and say that they find a way to get things under control. The crisis will be averted, just like every other crisis in history. The sun will rise again and the economy will keep chugging along.
We are in a small window of history. Just like the crazy bullish people of the late 1990s, I think the average investor is letting pessimism cloud their judgment a little. The financial crisis is still fresh in everybody’s mind. The American economy continues to suffer setbacks impeding recovery. It’s not a rosy picture out there, and I’m as guilty as anyone in being a little bearish. Stock market investors are generally not very good at looking at the long term.
The stock market is said to be a leading indicator. If you look at previous recessions, the stock market typically starts to go up a few months before the recession is over. The market looks at improving economic news and likes it, hence the increase in value. The stock market will also decline before a recession is official. The market is quite good at predicting what’ll happen in the short term. It’s really bad at predicting what’ll happen in the long term.
Predicting long term economic trends is hard. Who knows what new technology will even come out in the next decade, let alone the next half century. All I know is that it’s coming, it will be awesome, and that I will spend money on it. It’s okay though, because I’ll keep getting returns in the 8-10% range without even trying, thanks to broad market equity ETFs.
Looking back at our table, I’d like to focus on one period of time, from 1987 to 2008. In between those two years we had a massive stock market crash, (October 1987) a savings and loan crisis, (late 1980s-early 1990s) a subsequent recession, (1990-91) a large sell-off in real estate, (early to mid 1990s in both Canada and U.S.) a huge tech bubble, that said bubble bursting, 9-11, the bursting of the U.S. real estate bubble, and perhaps the worst credit crisis in history. A lot of stuff happened. Most of it was bad for investors.
Buying at the beginning of 1987 and selling at the end of 2008 means an investor bought high and sold low. And yet the market still returned over 8%. The market has done it for the last 100 years. I’m confident it’ll do it again. I’m willing to admit I don’t know squat, but I do know that.

Comments

  1. Echo

    Ok, while future long term returns of 6% per year might be a bit pessimistic, I would just like to point out that none of your time periods returned 12-15% either.

    When The Wealthy Barber and the Automatic Millionaire (among others) they used 12-15% returns as the norm. I’m suggesting that young people cut that in half when trying to plan for how much money they’ll need in 30 years.

    It’s easy to reach a million dollars when you just adjust the percentage return on your retirement calculator. I say, aim for a lower percentage and focus on increasing your contributions and savings rate instead. If you end up with 10% returns, then great…you can retire early.

    • Nelson Smith

      Yeah, that’s the big downfall of The Wealthy Barber. 12-15% returns are incredibly unrealistic long term.

      I can understand why you’d want to assume lower returns going forward as a type of insurance policy. If you assume a 6% return but get 8%, that’s good. If you assume 12% and get 8%, that’s bad.

      If I had a nickel for each talking head on BNN who says something to the effect of “returns will be lower going forward”, I’d have myself quite a few nickels. So, I just wanted to clarify that I wasn’t specifically picking on you. We’re still pals, right? Right????

      You mean I just can’t adjust my return to retire earlier? But I was counting on that. 🙂

  2. JT

    Six percent is the inverse of a P/E of 15. It’s a safe return for equities, considering no growth.

    That said, I expect to earn far more than 6% over the long haul.

  3. Jim Yih

    Great articles guys! My suggestion is to use multiple rates of return. You see, whatever rate of return you choose to use for the stock market will be wrong. If that’s the case why not project using 3 returns: a optimistic scenario, a pessimistic scenario and a middle ground scenario. It’s better to understand the range of possibilities that arises from uncertain returns. I appreciate the debate … I think this will be my Monday post!
    Jim

  4. JoeTaxpayer

    Funny, there’s the S&P numbers and we have a financial celebrity, Dave Ramsey, insisting 12% is the expected return over the long term. 6% may indeed be pessimistic, but given the choices (a) count on 6, but over time see you have gotten 10-12, or (b) count on 12, and after 30 years realize you need to lower your expectations for retirement because you got ‘only’ 10%, I’ll take (a) any day.

    We have our eye on a retirement date 6 years out. We need 8%/yr to get there, along with our savings each year. When I plug in 6% I get a new date 7 yrs 4 months away. So this is the range. It’ll be interesting to see what the rest of this decade brings.

    By the way. 1987? The year was positive. Anyone that slept through it (Rip Van Winkle style) woke up to an unremarkable return for the year of about 5%.

  5. Rachelle

    You know what? I predict smart savvy investors will keep making more money and those that buy BRE-X based on a tip received at the water cooler will continue to get hosed. Same with RE Investment.

    That’s the deal the sheeple suffer and the others do well.

  6. Miss T @ Prairie Eco-Thrifter

    We usually calculate using a 6% return. We figure this is pretty safe considering the historical averages. Considering we want to retire in just over 20 years, a 6% minimum return on investments should give us what we need to live off of.

  7. TJ

    6% is a safe number. But remember that inflation is likely to continue at about 3%, so you’re really only seeing a 3% net gain.

    Compare that to 10% historical return (7% after inflation) and you are working at a handicap compared to previous generations.

  8. Bret @ Hope to Prosper

    I expect healthy gains going forward in the stock market for a couple of reasons. First, inflation isn’t 3%, it’s actually closer to 6%, despite what the BLS publishes. This alone will push up the earnings and price of stocks, although the yield over inflation won’t be so great. Second, companies are announcing record earnings, mostly by squeezing employees. This will slow down as the recovery progresses, but they will be under intense pressure to retain those earnings levels.

    That’s my prediction and I hope to bank on it.

  9. Value Indexer

    It’s entirely possible there will be great stock returns in the next 10 years. But good predictions of long-term returns aren’t based on short-term events. A default in Greece probably won’t be as bad as what happened a few years ago (plus no one will be surprised), and so far that didn’t exactly keep the stock market down for 10 years (at least not yet).

    A slightly better basis for long-term forecasts (which would be closer to 10 years than 30 years) is what we’re paying today. With P/E ratios a little higher than average and the S&P 500 being well above what some have identified as a long-term trend, it’s less likely that we’ll see good returns from buying today. If you got drunk and bought an “S&P 500 share” for $3000 today, the chances that you could sell it at a profit in 10 years are pretty small.

    Sometimes prices are high for a good reason, and sometimes they aren’t. But with a stable index like the S&P 500 they are rarely extremly low for a good reason, so that’s when future returns look best. And most importantly, we should be investing regularly over a long period so we get a mix of different returns.

  10. Marcel

    It might help readers when you put a date in the header of the article, you cannot put things in perspective witout.

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