Are You Prepared for 5% Annual Returns for Years to Come?

by Darwin on November 30, 2011


In yet another common refrain from the Bond King Bill Gross, he stated this week (CNBC) that anyone realizing even 5% returns on stocks or bonds should consider themselves in the upper echelon of performers in the years ahead due to the debt issues in the EU and US which are anticipated to restrict growth for years to come (thesis being we’ve lived on years of false prosperity from borrowing money instead of living with our means and as we de-lever and enact austerity, this will crimp GDP in western nations).  This is a far cry from the long-term historical averages and “rule of thumb” 8-10% returns for equities (including dividends) and the 5% or so for bonds (average returns, not “best in class”).  His thesis is sound, it’s just that even the most prolific investors tend to make bold calls and then they’re wrong most of the time (I’m still waiting for all those muni bond defaults Whitney called for last year).  Let’s say this is how the world plays out though – it will be quite ugly.

Life in a 5% Return World

This has a broad range of implications for retail investors, institutional investors, pension funds, endowments, states and municipalities.
For one, many people (especially the elderly, insurers, pension funds) rely on income investments.  Since they’re not getting it, many have shifted their investments into riskier assets seeking higher returns.  If these returns fail to appear, but carry much higher volatility, this will continue to wreak havoc not just on them, but have unintended consequences.

If pension funds are unable to achieve their already ridiculously high stated target returns of 8% or more, they will continue to appear to be alarmingly “underfunded”, much more so than they already are today.  What are the implications?  Well, they’ll need to either increase their target returns even further (I think they’ve played that card one too many times, using 8-8.5% in many cases while realizing closer to 5-6% over the past several years), or actually fund their obligations.  That, in turn, would mean companies have to take a hit to earnings to fund their pensions, states and municipalities would need to raise taxes to cover the shortfalls, college endowments would need to fund fewer scholarships to maintain their capital and numerous other implications.
If there’s any wonder why the past two administrations went to such great lengths to save the banks, prevent a financial meltdown and boost stock prices over the past few years, the reasons cited above were the motivating factor.

With the government’s questionably realistic inflation benchmarks in the 3% range and the “real” inflation most Americans actually feel when accounting for skyrocketing healthcare costs, college tuition inflation, food costs, gas costs and more at something more like 5-6%, this scenario of maximum returns of 5% in the coming years could actually mean a generation of no “real” investment gains.  Basically, even by taking on aggressive investment strategies and performing best-in-class, you’re breaking even?!?

Not exactly a rosy scenario, but one you should perhaps plan for.

What are your thoughts on future investment returns?

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{ 3 comments… read them below or add one }

1 Brian November 30, 2011 at 9:44 pm

5% seems realistic, if not optimistic for most U.S. portfolios.

Consider a 50/50 portfolio consisting of:
10-yr governement bonds yielding 2.1%
S&P 500 with a dividend yield of 2.0%

Using the “Gordon Equation” we can assume nominal S&P 500 returns in the 55-6% range. A 50/50 split of these two asset classes gets you only a 3.5%-4.5% nominal return.

Pretty bleak.


DonM Reply:

@Brian, If 5% is the rate of return, and productivity grows by 9%, we may expect a period of deflation.

Deflation means that money under your mattress has more purchasing power when you pull it out. Your estimate that you need 50,000 a year to maintain your lifestyle must then be adjusted: 10 years from now you will need substantially less.

In times of inflation, you must invest, so your money grows to keep up with and surpass inflation. In times of deflation, you keep your money in cash, and your return is from the decrease in other people’s money- you have less competition for goods.


2 Her Every Cent Counts December 2, 2011 at 1:32 am

I always assume 3% when working w/ compound interest calculators when I try to figure out how much I save to retire one day… and then I cry a bit.


3 Rick @ Invest In 2012 February 28, 2012 at 5:36 pm

“The owners are selling out” Exactly what I was thinking. They need to land the public some expensive stock so that they can cash out their illiquid stock.


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