Any predictions for future asset values involve assumptions about the rates of return of particular investments. Usually there's a history to look at — perhaps a very long history of over a century — so you can at least say with confidence how a particular investment has done in the past.
Of course, there's always this disclaimer that is repeated so often it's trite: Past performance is no guarantee of future results.
So when I read articles that make predictions, I check the rates of return. Here's an example from Money magazine:
Why It Pays to Put More Stock in Retirement
The article argues that a 50-50 mix of stocks vs. bonds and cash will serve you better in 30 years than a more “conservative” mix of 20-80 stocks to bonds and cash. The article's assumptions for the APYs are as follows:
- Stocks: 8.8%
- Bonds: 5.8%
- Cash: 3.3%
Also assumed is 3% annual inflation.
The scenario starts with $500k, of which 4% is drawn out for retirement expenses ($20k) and 3% more each year afterward for inflation. But this really doesn't matter. The end result is that the portfolio with the higher mix of stocks beats out the portfolio with the lower mix.
Which is no surprise, given the assumptions: Stocks return more than bonds or cash.
Stepping out of the scenario now: Will they return 8.8% per year over the next 30 years?
Or for that matter, will inflation stay at 3%, or will it be higher?
Where do these numbers come from? Are they conservative, or optimistic, or just plain wrong?
I'm pretty sure that these assumptions are not deliberately misleading, but I disagree that things will be business as usual for the next few years, and possibly for the next couple of decades. Our financial situation as a country is a lot worse than it was 30 years ago, and global competition for our jobs will likely hurt us. I see other countries enjoying close to 9% a year for the next 30 years, but not ours.
Of course, my crystal ball is in the shop along with everyone else's. However, $500k to my name and $20k in today's money per year isn't exactly luxury, and I don't want to count on an S&P 500 index of 10,000 or so by 2036 just to avoid running out. As a pessimistic assumption, I'd look at the cash return as a benchmark rather than the stock return. Now, $500k at 0.3% above inflation wouldn't last long, but that's the point: I would need more than $500k to retire comfortably. It gets you saving more and looking for ways to increase your income a little more urgently than an assumption of 5.3% stock rate of return above inflation would.
Now that you've heard what I think about rates of return, what do you think? Are the rates too high? Too low? Just right?
John,
I think Walter's assumptions are decent. Think about the fact that the S&P 500 has returned north of 10% over the last 30 to 40 years. Now think of all the stuff we went through as a country: Watergate, rampant inflation, high oil prices, terrorism, savings and loan crisis, scandals, internet bubble,… the list goes on and on. And yet, the S&P 500 kept chugging along.
If you haven't done it yet, read both of Jeremy Siegel's books (Stocks for the Long Run and The Future for Investors). Those books should help shed some light on asset class returns.
Finally, bonds and cash are horrible inflation hedges. As long as inflation is in check, stocks represent the best inflation hedge because during periods of rising prices, companies can raise prices.
Good post.
JLP, thanks very much for your comments!
You had mentioned Jeremy Siegel to me before, and as is typical for me, I have a mind like a sieve, so I didn't read the book.
I've been lax about monitoring my investments in the past, and my skepticism about future returns stems from that. The outlook for the S&P 500 index is always rosy for the index fund managers, bonds for the bond bulls, real estate for the Realtors, etc. Who do I believe, and what stake do people have in their recommendations to me? are the questions I'm starting to ask.