I hope you’re sitting down. No one wants to hear this, but it really needs to be said. Ready? Here goes: your return expectations for the foreseeable future are almost certainly too high. They may even be shockingly high. Our friends at Vanguard recently released their outlook for 2020 and the return expectations for the next decade are, in my view, entirely reasonable. Alas, most people are taking a pie in the sky approach to investing and looking at capital markets through rose-coloured glasses. Don’t shoot the messenger, but the future looks to be a lot more challenging than the recent past.
When we do planning work for our clients at STANDUP, we take a long-term view, which, to us, means 20 years or more. Obviously, the long run is nothing more than a series of short run outcomes strung end to end. Some of those short-run experiences will be quite good; others quite challenging. What is not really questioned is that over time, those experiences revert to the mean. Seeing as the past decade has been very good by almost all metrics, it would stand to reason that the next decade will likely be more challenging than, say, the next two decades. Stated differently, many reasonable people would likely opine that the expected returns for the period from 2020-2030 will likely be worse than the period from 2030 to 2040.
For some time now, we’ve been assuming nominal returns of 7% for equity and 2% for income. Those are the numbers for benchmarks over 20+ years. Benchmarks have no MERs and charge no advisory fees. Reputable planning requires that those expenses should be backed out (i.e. the returns lowered) to reflect their existence. Even though many people have suggested that the STANDUP assumptions are too conservative, few acknowledge that since they are for the next 20+ years, the assumptions for the next ten years ought to be lower still. The Vanguard outlook recognizes this. These folks have the expected median return for equity set at 5.1% and the median income return set at 1.9%. Conveniently, a 50/50 projection for Vanguard (next decade) is set at 3.5% before fees and a 50/50 projection from STANDUP (next 20+ years) is set at 4.5% before fees. There seems to be a consensus that things will get worse before they get better… although “better” may still be worse than what you expected to be “normal”.
If your financial plan is written using return assumptions that are higher than what is listed here, you may need to either:
- Work longer
- Save more
- Retire later
- Prepare for a more modest lifestyle than you previously expected
No one likes to hear bad news. The “lower orbits” that Vanguard talks about are a very real concern for people preparing for retirement. Virtually everyone I talk to is using numbers that are simply unreasonable. My question to you: how can we motivate people to take action in light of challenging circumstances where few people will even recognize the challenge, much less engage in purposeful behaviour to address it?