In the “new normal” landscape of global investment markets and sputtering economies, big swings in the market from day-to-day have gained attention. Volatility creates headlines but the aspect of the new normal that is more important to your financial security is the expectation for relatively low investment returns.
I use data of past returns that go back to 1973. In the period from 1973 through 2011, a balanced portfolio of 60 percent global stocks and 40 percent bonds posted average annual returns of 10.27 percent. It was a spectacular 39-year run for bonds and the average returns were skewed upward by the great stock market climb of the late 1990s.
Narrow the data to the past 12 years, 2000-2011, and the average annual return for the same mix of investments was 5.19 percent.
Will returns go back to the averages of the past four decades? Or will the more recent past extend its misery? I think planning for a return of more than 10 percent on a balanced portfolio over the next 10 years is reckless.
At the same time, you are safe to expect a bit more than 5.19 percent returns over the next several years for a globally balanced mix of stocks and bonds.
If the world experiences a subpar economic recovery, but not a global recession, you can reasonably expect U.S. and mature international stock markets to reach 7 percent average annual returns over the next few years. Emerging-markets stocks could bring a couple percentage points more. The bigger difference compared with longer-term returns can be expected to come from bonds and cash. International bonds and high-yield “junk” bonds could bring 5-6 percent returns but investment-grade bonds aren’t likely to outrun inflation. A 4 percent return might be a stretch for the highest rated government and corporate bonds. Cash will certainly continue to be a big drag on portfolio performance.
Projecting returns is imprecise at best. Your personal returns will be dictated by a combination of factors.
WHAT IS YOUR INVESTMENT MIX?
Your decision how to weight stocks, bonds and cash will be more influential on your outcome than any of the individual stock or bond holdings.
A neutral starting point for most diversified investment mixes generally includes 60 percent stocks and 40 percent bonds/cash. You can turn the stock percentage up or down depending on your preference to invest more aggressively or conservatively.
Before you even pick an investment, this decision will carry the most weight in determining expected returns.
OUTCOMES THAT INFLUENCE MARKETS
Your investment character – conservative, balanced or aggressive – will determine to what extent your returns will be helped or harmed by the various economic and market outcomes.
Considering the increasing connection between global markets and economies, there are generally three potential outcomes for 2012 and beyond. The best and worst-case scenarios center on global debt and whether challenges will be solved quick and calmly or slow and painfully.
It seems probable that the world will likely experience a middle outcome where the standard of living doesn’t advance as rapidly as it has on the shoulders of debt and the world dodges the worst but falls short of the best of times.
Your investment returns will generally be determined by an equation that matches your portfolio character with the market outcome. Aggressive investors in best-case outcomes will generate higher returns. With a different outcome, conservative investors may lead, like they have most of the time since 2000.
DON’T BET ON THEM, BUT PLAN FOR THEM
Given the possibility that returns for the rest of this decade could be as choppy and unrewarding as the last, I think everyone is better off to plan for low returns and hope for the luxury of being wrong. If markets actually work out more in your favor, only good things can come of it.
In order to earn even the lower “new normal” returns, it becomes exceptionally important to minimize declines in down markets. That doesn’t mean go to cash when you lose confidence and return to the markets when you feel better about their prospects. It means during periods of market dysfunction, you will need to adjust your investment mix.
Being flexible at the edges of your portfolio can allow you to take advantage of mispriced assets in a way that can both reduce risk and increase returns. However, it requires active management. You shouldn’t expect to get the same results in a set-it-and-forget-it target date retirement fund.
Regardless of your investor profile or the outcome of global market events, earning and keeping investment returns will be reliant on conviction in your strategy. Blowing it up and starting over each time an outcome deviates from expectations is a sure path to ruin.
Gary Brooks is a certified financial planner and the president of Brooks, Hughes & Jones, a registered investment adviser in Old Town Tacoma. Reach him at gary@bhjadvisors.com.
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