Lower Your Expectations for Returns Over the Next Decade

The best you can hope for is modest gains. The solution? Save more.

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Most financial pundits will tell you that the average annual return from large-company stocks since 1926 is 10.1%. If your investment horizon is a very long way off, you may well get that much. Over any given decade, however, there is a huge variation from the long-term average.

No one has a crystal ball, but you can make assumptions based on current economic trends, corporate earnings projections and stock prices. And that can give you an idea of how much to invest in stocks, bonds and cash over the next decade.

A lot to live up to. Standard & Poor’s 500-stock index averaged a 14.0% annual gain, including dividends, over the past 10 years. Don’t expect that for the next 10 years. Brian Singer, head of the Dynamic Asset Allocation Strategies team at institutional investment house William Blair, thinks large-company stocks—such as those in the S&P 500—will gain a below-average 6% annually over the next decade.

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Blame the bull market. The run that began in 2009 is the longest bull market ever, and it has gained three times the amount an average bull market does. Typically, big bull markets are followed by big losses, says Sam Stovall, chief investment strategist of U.S. equity strategy at CFRA—say, 40% or more. A bear that big would tear a hunk out of the stock market’s projected 10-year return.

You might increase your stock returns by investing abroad—especially in emerging markets, if you can tolerate the risk. It’s a matter of playing catch-up. Foreign stocks have lagged their U.S. counterparts over the past decade, particularly lately. The MSCI Europe, Australasia and Far East index has fallen 9.0% over the past 12 months, and the MSCI Emerging Markets index has fallen 8.7%. The S&P 500 is up 1.8% over the same period.

Foreign currencies have fallen against the U.S. dollar as well, and if they rebound, they could put some extra octane into your portfolio as returns earned abroad translate into more dollars here. “The odds are 90 to 10 that emerging markets will beat U.S. stocks,” says Rob Arnott, founder of Research Affiliates. He’s forecasting a 9.7% annualized return for emerging markets over the next decade—about the same as their 30-year average. Foreign developed markets, where earnings growth is slower than in emerging markets, should return 7.5% annualized over the next decade, he says.

Bonds will disappoint. Government bonds have earned an annualized 5.0% since 1926. It’s unlikely that interest rates will return to the long-term average, which includes the towering yields of the 1970s and early 1980s. In today’s global and disinflationary economy, the 10-year yield is unlikely to rise above 4%, up from 2.9% recently. Mix in the likelihood of principal losses as yields drift higher (prices and yields move in opposite directions), and you get disappointing bond returns over the next 10 years. “We see a 2.5% to 4% annual return from bonds,” says Roger Aliaga-Díaz, senior economist at Vanguard’s Investment Strategy Group.

Cash is the third asset class in a balanced portfolio. Barring a surge in inflation, the Federal Reserve is unlikely to push up its benchmark short-term interest rate much past 3%, and savings rates follow that closely. A 3% return from cash over the next 10 years wouldn’t be unusual: Treasury bills have returned an average 3.3% a year since 1926. What’s unusual is how close cash returns could be to bond returns. Just don’t give up on bonds. You’ll want them in your portfolio if there’s a recession and a bear market in stocks.

If the next decade produces lower-than-average returns on stocks and bonds, your best bet is to save more. If you increase your saving rate, and your investments provide more than the middling returns expected, you won’t just reach your goals, you’ll roar past them.

John Waggoner
Contributing Writer, Kiplinger.com
John Waggoner has put personal finance and investing into plain English for more than three decades. He was a senior columnist for InvestmentNews and, prior to that, USA TODAY's personal finance columnist for 25 years. He has written for Morningstar, The Wall Street Journal, and Money magazine. Waggoner has also written three books on finance and investing. He has an undergraduate and graduate degree in English literature and is working on his Certified Financial Planner designation. He lives in Vienna, Virginia.