Newspaper article Sarasota Herald Tribune

Planning for Next Decade's Returns

Newspaper article Sarasota Herald Tribune

Planning for Next Decade's Returns

Article excerpt

THE RATIONAL INVESTOR

Pension funds and insurance companies have a long-term investment horizon. Thus, they base their investment strategy not on recent securities' markets returns but on their expected returns over at least the next decade. Unfortunately, many individual investors suffer from "recency bias;" which is when investors forecast future performance based solely on recent results.

In actuality, most investors aren't that dissimilar to pension funds, as they often have time horizons of many decades. This is especially true with retirement savings. Thus, it makes sense to look at long-term historical returns and likely future economic scenarios to get context for forecasting future returns. Using these factors, I'll provide one scenario for returns for the next decade.

Studies of the real (inflation-adjusted) annualized returns of asset classes in the U.S. since the late 1800s have found stocks annually returned 7 percent, bonds 3 percent and cash 2 percent.

Annualized inflation will be close to the Federal Reserve's 2 percent target. Europe will slowly climb out of its economic hole with even lower annualized inflation than the U.S. and also economic growth lower than that of the U.S. These issues will affect the U.S. For example, it will limit the growth of exports by U.S. companies to Europe.

China, historically Asia's engine of growth, won't pick up the slack, as it will have its own problems as it adjusts to lower exports and shifts to more internally driven economic growth. China's economic growth rate has fallen from double digits to below 7 percent, perhaps in reality in the 5 percent range, and it will at best remain there.

The U.S. economy will likely continue to do better than Europe's, with the next decade's annualized real growth rate in the range of 2.25 percent and inflation-adjusted corporate profit growth in the same range.

One way to estimate equity returns is to add dividends to earnings growth and to changes in price-to-earnings ratio, or "P/ E. …

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