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:
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.