Expected long term returns

With the economic upswing now well into its tenth year (even though it may not feel like an economic boom!), many "experts" are predicting a recession coming soon, as this is one of the longest economic growth periods in history, albeit with somewhat pedestrian growth rates, compared to previous economic booms.

On most traditional valuation metrics, such as Price to Earnings (PE), stock valuations look full at best. Of course - when compared to historically low interest rates, equities still offer relatively good value - a fact that has at least supported the equity market rally over the last nine years.

After a fulminant start to the current year, based in large part on the tax cuts introduced by the trump administration, the market experienced its first correction of 10% in February, bringing to the fore again the valuations of the markets and fears for performance.

As of last Friday, the FOOTSIE 100 has since regained a new all time high.

What are investors to make of such volatility in the markets?

I am not going to comment/predict what's likely to happen in the near future (3-5 years!!!) - there are plenty of "experts" out there, doing just that. In these times of heightened volatility and "noise" in the markets, it is quite easy to lose the long term perspective for one's investments.

Let us rather take a look at the long term returns of assets: (all figures from: Jeremy Siegel, Stocks for the long run)

From 1802 until 2001, annual stock market returns (US market) returns were 8.3% compounded annually, incl. dividend yields of 5.2%, while inflation during the same period averaged 1.4%, giving a total 'real' return of 6.9%.

This period obviously included two world wars with their negative impacts.

Looking at the same figures for the period 1946-2001, we arrive at a total 'real' return for stocks of 7.1%.

From 1802-2001, the 'real' return for Long Term Bonds (US Government) was 3.5%, while Short Term Bonds (as proxy for cash) returned 2.9%.

Equally, for the period 1946-2001, LTBonds real return was 1.3% and STBonds 0.6% respectively.

As a proxy for more aggressive commodity investments, gold during the period 1802-2001 returned 0% in real terms and -0.3% in real terms during 1946-2001. This is not surprising, as this asset does not generate any income and returns are based on capital appreciation only (or currency depreciation!)

Lets also have a look at the returns that investors realised during the entire period (1802-2001) over various holding periods.

Source: Stocks for the long run by Jeremy Siegel

As can be seen from the chart, over the short term (1,2,5 years), stock returns offer considerably higher downside risks then Bonds or cash in real terms. However, for holding periods of 10 years and beyond, this relationship reverses and there is no 30 year period in which stocks would have underperformed bonds or cash, nor would they have lead to any negative real returns (unlike bonds and cash).

Although we all know that historical returns do not guarantee future results, these statistics certainly favour equity investments, provided the investor stays in it for the long term (10 years and beyond!).

Source: Stocks for the long run by Jeremy Siegel

Let us now look at what the returns would have been for a "diversified" medium risk portfolio during the period above (1946-2001) and what we can possibly expect going forward.

For a medium risk investor, let us assume the following weightings in her portfolio:

Weight exp. Return weighted return

Cash: 3-15% 0.6% 0.0540

LT-Bonds 10-45% 1.3% 0.3575

Stocks 40-80% 7.1% 4.26

Gold 1-15% 0% 0

Total: 100% 4.6715

And while these returns may not seem fantastic to the current investor, they easily beat cash returns both, in the long run as well as in the short run.

Although there is a lot of "noise" in the markets and debates as to why "this time its different", there is no reason that I can see why these long term relationships between asst classes will change, nor why the long term returns should be materially different. The argument of the shrinking population problem (with the baby boomers coming up to retirement and "unsaving" their pension pots) is counterbalanced by the developing world creating more wealth and stronger savings.

The 'ageing' industrial age is offset by the 'technology' age and while this is all happening with great disruption to the established status quo, a diversified portfolio as above is still offering the best expected return outcome over reasonable long periods, bearing in mind that most investors lifetime investment periods extend together with life expectancy.

The baby boomers were likely starting to save around age 30 and continued until age 65, hence a 35 year "holding/investing" period.

As as a population we are growing older and the average 55 year old male in the developed world can now expect to live to 90 and therefore are likely to work well into our 70's, the lifetime holding/investing period is also extended by a good 10 years.

Anybody considering their investments and who is becoming fearful about their investments by all the news and media reports about wars, trade wars, Brexits etc should bear the above in mind and not loose the long term perspective. The importance is not what happens in the short term, but how long will you be invested (in any asset class) in total time over your investment lifetime. If that number is 10 years and beyond, don't give in to the doomsayers!

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