10 Year Expected Returns

10 Year Expected Returns

Posted On March 3, 2021 By Scott Stratton, CFP(R), CFA In Portfolio Management /  

With the market rising so fast in the past year, investors are wondering if the 10 year expected returns are still attractive. Are we in a speculative bubble? Other investors see certain stocks soaring and are driving prices even higher. Will recent returns continue? While it’s natural to fret about the future of the stock market, we suggest investors resist the temptation to try to time the market.

It may be helpful, however, to evaluate current valuations and consider how to weight a diversified, buy and hold portfolio. Based on present levels and projected growth, the Vanguard Capital Markets Model calculates the 10 year expected returns for various asset classes. We use this information both in our portfolio construction as well as in our financial planning calculations.

Expected returns today are lower than historical returns. The stock market has risen much faster than corporate earnings. Now, companies need to catch up with their stock valuations. Dividend Yields are lower than historical, as well as economic growth and inflation. All of these are components of projected future Equity returns.

Vanguard recently updated their 10 year expected returns, based on market levels on December 31, 2020. You can compare these figures to six months ago, when I last wrote about Vanguard’s estimates.

Vanguard’s 10 Year Expected Returns

  • US Stocks: 3.0% to 5.0%
  • International Stocks: 6.1% to 8.1%
  • US Growth: -0.1% to 1.9%
  • Value: 4.4% to 6.4%
  • Large Cap: 2.9% to 4.9%
  • Small Cap: 3.2% to 5.2%
  • US REITs: 3.0% to 5.0%
  • US Aggregate Bonds: 0.8% to 1.8%
  • International Bonds: 0.6% to 1.6%
  • Emerging Markets Bonds: 1.5% to 2.5%

These estimates are 10 year annualized projections and are not guaranteed. There will undoubtedly be down years and this is not meant to suggest returns over the next year or in the short-term. Investing involves risk of loss of capital. Source: Vanguard Market Perspectives, March 2021.

Key Takeaways

  1. 10 year expected returns are lower than historical returns. I have cautioned in the past about using historical returns in financial planning projections. We use projected returns. Based on the midpoint of Vanguard’s figures, a 60/40 portfolio with 30% US Stocks, 30% International Stocks, and 40% US Aggregate Bonds has a projected return of 3.85% a year. This may cause some investors to rethink their allocations.
  2. US Growth Stocks are overvalued. US Value is more attractive for a long-term investor today. Be careful of chasing 2020’s hot stocks! We have already built a sizeable position in Value stocks in our models.
  3. International Stocks are more attractive than US Stocks. Be diversified and don’t invest in just US companies. Presently, International Stocks make up 43% of the World Index. If you don’t have at least 43% of your equities in International, you have a Home Bias. This may have worked well in the past decade, but appears less likely to be the case for the next 10 years.
  4. US Small Cap may offer a diversification benefit to Large Cap. REITs on the other hand, have the same return profile as US Stocks, but are riskier (higher volatility). So, we are avoiding REITs in our models.
  5. Bonds and Cash serve primarily as portfolio defense today. They offer little return potential. Vanguard projects inflation will be 1.1% to 2.1% over the next 10 years. Bond and cash returns may be less than inflation, which means you are losing purchasing power. Still, fixed income offers some benefits to rebalance when things are volatile. On their own, bonds are not making much of a positive contribution to portfolio returns.
  6. Preferred Stocks, Convertible Bonds, and Emerging Markets Bonds offer an attractive return potential compared to expected returns on core categories like US Stocks or US Aggregate Bonds. We have expanded our Alternative holdings in 2020 and again in 2021. Read more: Investment Themes for 2021.

Stay Diversified, Don’t Speculate

While we do tilt portfolios towards areas of relative value, it is important to remain diversified. Don’t put all your eggs in the one basket with the highest expected return. There’s no guarantee that Vanguard’s projected returns will become reality. Regardless of short-term market movements, our investment strength comes from keeping costs low, using Index strategies, staying diversified, and tax-efficiency.

The stock volatility over the past 12 months has been remarkable. But, it’s not unprecedented, though. I remember the Tech Bubble in 1999 and the rebound 12 years ago, from March of 2009. Both of those created rampant speculation, which we see today in certain growth stocks, cryptocurrency, and in the options market. Have we not learned the painful lessons of previous day-traders and those who gambled on stocks? Recently, individual investors have been asking me about trading options, Penny Stocks, and day trading stocks with the money they have set aside for a house down payment in one year.

Even as Vanguard is lowering its 10 year expected returns, people are getting greedy, with the fear of missing out on their chance to get rich. They know someone who got lucky over the past year and made a great trade. The lesson from the past is that everyone is a genius in a Bull Market. You could do no wrong in the past year, as long as you did something. Things won’t always be that easy, and that’s why you need a plan. Please make your investment choices about the next 10 years, and not the next 10 hours or 10 days.

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What Are Today’s Projected Returns?

Posted On June 18, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning, Portfolio Management /  

One of the reasons I selected the financial planning software we use, MoneyGuidePro, is because it offers the ability to make projections based on historical OR projected returns. Most programs only use historical returns in their calculations, which I think is a grave error today. Historical returns were outstanding, but I fear that portfolio returns going forward will be lower for several reasons, including:

  • Above-average equity valuations today. Lower dividend yields than in the past.
  • Slower growth of GDP, labor supply, inflation, and other measures of economic development.
  • Higher levels of government debt in developed economies will crowd out spending.
  • Very low interest rates on bonds and cash mean lower returns from those segments.

By using projected returns, we are considering these factors in our financial plans. While no one has a crystal ball to predict the future, we can at least use all available information to try to make a smarter estimate. The projected returns used by MoneyGuidePro were calculated by Harold Evensky, a highly respected financial planner and faculty member at Texas Tech University.

We are going to compare historical and projected returns by asset class and then look at what those differences mean for portfolio returns. Keep in mind that projected returns are still long-term estimates, and not a belief of what will happen in 2017 or any given year. Rather, projected returns are a calculation of average returns that we think might occur over a period of very many years.

Asset Class Historical Returns Projected Returns
Cash 4.84% 2.50%
Intermediate Bonds 7.25% 3.50%
Large Cap Value 10.12% 7.20%
Small Cap 12.58% 7.70%
International 9.27% 8.00%
Emerging Markets 8.85% 9.30%

You will notice that most of the expected returns are much lower than historical, with the sole exception of Emerging Markets. For cash and bonds, the projected returns are about half of what was achieved since 1970, and even that reduced cash return of 2.50% is not possible as of 2017.

In order to estimate portfolio returns, we want two other pieces of data: the standard deviation of each asset class (its volatility) and the correlation between each asset class. In those areas, we are seeing that the trend of recent decades has been worse for portfolio construction: volatility is projected to be higher and assets are more correlated. It used to be that International Stocks behaved differently that US Stocks, but in today’s global economy, that difference is shrinking.

This means that our projected portfolios not only have lower returns, but also higher volatility, and that diversification is less beneficial as a defense than it used to be. Let’s consider the historical returns and risks of two portfolios, a Balanced Allocation (54% equities, 46% fixed income), and a Total Return Allocation (72% equities, 28% fixed income)

Portfolio Historical Return Standard Deviation Projected Return Standard Deviation
Balanced 8.53% 9.34% 5.46% 10.59%
Total Return 9.18% 12.20% 6.27% 14.23%

That’s pretty sobering. If you are planning for a 30-year retirement under the assumption that you will achieve historical returns, but only obtain these projected returns, it is certainly going to have a big impact on your ability to meet your retirement withdrawal needs. This calculation is something we don’t want to get wrong and figure out 10 years into retirement that we have been spending too much and are now projected to run out of money.

As an investor, what can you do in light of lower projected returns? Here are five thoughts:

  1. Use projected returns rather than historical if you want to be conservative in your retirement planning.
  2. Emerging Markets are cheap today and are projected to have the highest total returns going forward. We feel strongly that they belong in a diversified portfolio.
  3. We can invest in bonds for stability, but bonds will not provide the level of return going forward that they achieved in recent decades. It is very unrealistic to assume historical returns for bond holdings today!
  4. Investors focused on long-term growth may want more equities than they needed in the past.
  5. Although projected returns are lower than historical, there may be one bright spot. Inflation is also quite low today. So, achieving a 6% return while inflation is 2% is roughly comparable in preserving your purchasing power as getting an 8% return under 4% inflation. Inflation adjusted returns are called Real Returns, and may not be as dire as the projected returns suggest.
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