CERTIFIED PUBLIC ACCOUNTANTS AND ADVISORS |
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DO YOU HAVE REALISTIC MARKET EXPECTATIONS? What kind of market returns do you expect in the coming
decade? Will stocks bounce back to the high returns of the late 1990s, equal
historical averages or slip below that? Will the returns you anticipate be
enough for you to meet your personal financial goals? What will you do if
returns come in below average? Or are you uncertain as to what the market will do and not
sure what to do next? Join the crowd. One of the hot topics among investment experts today is not
whether we’ll see a return soon to the double-digit performance of the
1990s—most concur we won’t—but just how much lower the market will perform
in coming years. Even a cursory review of the professional literature and
overheard debates among investment advisors quickly reveals that the vast
majority of experts anticipate yearly stock market returns in the single digits
for at least the next decade, perhaps longer. Many CERTIFIED FINANCIAL PLANNER™
professionals cautioned investors during the heyday of the late 1990s about the
inevitable market decline, and that has come true. The questions today are, how
low will returns sink and how long will lower returns stay? Many experts expect annual total market returns (before
adjusted for inflation) of seven to nine percent. That’s not only below the
lofty returns of 1995–1999, but below the historical average of around 11
percent for large-cap stocks and 12 percent for small-cap stocks. These same experts estimate a modest risk premium—the
extra return that stocks would earn above a risk-free investment, usually U.S.
Treasury bonds—in the range of three to four percent. This, too, is well below
recent risk premiums of six to seven percent or higher. Some investment experts are even less optimistic, citing
what they consider an overvalued market. One argued in a recent article in the Journal
of Financial Planning that the future risk premium will be
zero—essentially saying that stocks won’t do any better than bonds in the
coming years. These viewpoints of future equity returns differ sharply
with the far more optimistic view of the investing public. Although a poll by
the Vanguard Group toward the end of 2001 found investors anticipating returns
averaging only seven percent over the next year or two, these same investors
were rosier about the long term. They saw returns averaging 15 percent over the
next two decades—about the same as 1985–2000. One-fourth predicted stock prices to average 30 to
100 percent annually, which is virtually impossible to sustain for that long,
say experts. Assuming the experts are reasonably accurate in their
predictions—and one can never be sure when it comes to the stock market—what
should you do? First, be realistic. If the historical average for stocks
is around 11 percent, why assume that stocks will return 30 percent for the next
20 years? Many financial planners assume a modest overall portfolio return
(usually a combination of stocks, bonds, cash and perhaps other investments) of
around seven to nine percent. Don’t invest backwards. Many people start by assuming the
stock market will return a certain rate (often high) and then save and plan
accordingly. Instead, suggest many planners, start first by clarifying your
personal goals—retirement, a college fund, money to start a small business.
Next, determine how much money you will need to accumulate in order to achieve
the goals, calculate a modest return on your investments, and then arrive at a
figure of how much you need to invest each month. This avoids the risk of undersaving or having to save
longer than planned, which is what happens when you assume unrealistically high
returns. And should the market exceed expectations, you won’t have to borrow
as much for college, can take more vacations during retirement or even retire
earlier than planned. Diversify more. Don’t concentrate on bigger single bets.
If stock returns slow down, other types of assets such as bonds or real estate
may pick up some of the slack. Higher net worth investors may want to explore
alternative investments, such as private equity, commodities and hedge funds.
Remember, the object isn’t to beat the market…it’s to reach your financial
goals. Save more. This is the most reliable way to compensate for
lower returns. Watch taxes and fees more closely. It was easy to overlook them during the bull market, but they take a bigger bite when investment returns are lower. May 2002— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by McGuire & Co., LLP, a local member in good standing of the FPA. |
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