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

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?