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Updated Monday, November 5, 2012 at 04:35 PM

Chuck Jaffe: Alter your market expectations, permanently

By Chuck Jaffe
Syndicated columnist

Your Funds

As the stock market went through its recent “celebrations” of the 25th anniversary of the single worst day in its history — the crash of 1987 — most experts said investors should expect similar crashes and free-falls in the future.

Lost amid those headlines, however, was what experts said investors should not expect to see again for the foreseeable future, namely the kinds of historic returns they came to expect before and after that crash, and that most people expected to get for a lifetime.

Ask most investors what they expect to get from the stock market, and the answer typically comes out at 10 percent. That’s an homage to an old study by Roger Ibbotson and Rex Sinquefeld that showed several generations of investors that stocks average that return over time, albeit before any transaction costs.

No matter how much the market has bounced around — through periods where a 10 percent return lagged badly and downturns where a double-digit gain felt like a fairy tale — investors typically have the sense that if they stick with the market long enough, they will come away with that 10 percent gain.

The problem is the experts, including Ibbotson himself, don’t believe it.

“Starting in 1926, the return on the large-cap market has been 9.8 percent, but this was during a period when inflation rates are higher than they are today, and risk-less rates were higher than they are today,” said Ibbotson, a Yale professor who also serves as chairman and chief investment officer at Zebra Capital Management.

“You have to knock it all down by a couple of percent, because we really are in a risk-less rate environment where the rates are close to zero.”

For the next quarter-century or more, Ibbotson said he would “not predict more than an 8 percent return on the market, but that’s not bad. That’s a great return.”

Likewise, Vanguard Group founder Jack Bogle said the current market, which he called the “most challenging he has ever seen,” is going to deliver smaller returns than what experienced, adult investors have in their heads.

He pegged the return in the 6 to 8 percent range for stocks going forward, also citing low yields and low inflation as key reasons to alter long-term expectations.

Of course, a lot of investors would be thrilled to get 8 percent these days, a far sight better than the returns they have earned over the last decade. But if history has not been suspended — and the experts don’t think it has been, they just believe returns will be lower — the lowered expectations do significantly change long-term financial and investment planning.

Consider someone who starts investing in their 20s and has a long life ahead of them. A 10 percent return would double their market return every 7.2 years, compared with a 9-year time frame when the return is just 8 percent.

If their initial investment was $10,000, it would be $160,000 in 36 years if it compounds at 10 percent annually. It would be half that amount over the same time period if the return is 8 percent.

“The challenge is that inflation is still in the 2 percent to 3 percent range … and the real challenge for investors is that they really can’t get to where they want to be with a less than 2 percent Treasury bond, combined with a 6 percent to 8 percent stock market,” said Jeffrey Coons, president of the mutual-fund firm Manning & Napier.

“You combine those together and you never really get to those numbers you use in your retirement calculators, or that a pension plan would use for its actuarial assumptions. Those absolute returns really are the issue,” Coons said.

Aside from changing the assumptions they plug into those calculators — a move that makes the ultimate outcomes look significantly more bleak and doubtful — experts are split over what investors should do as a response to this less fruitful environment.

Average long-term investors have always tried to capture the long-term trends; it’s why low-cost indexing has delivered so strongly over time.

Now, however, those indexes are poised to return less, which Coons suggested could pull investors away “from buying the whole stock market and bond market and focusing on individual investments that are priced to give you better returns.”

Ibbotson had other ideas, namely to get a realistic handle on spending needs, and to save more.

“We’ve been talking about these lower returns for a few years now,” Ibbotson said, noting that the stock market’s volatility and lack of strong returns over a decade have scared off a lot of investors. “But I don’t know that most people have responded. They haven’t changed their expectations, or increased their savings or tried to figure out if they will really have enough if the market isn’t as good over the next 25 years as it was for the last 75.

“One way or another, however, I think most people have to change their behavior, change their equation. That’s the only way this turns out over the coming decades the way people expect and hope for.”

Chuck Jaffe is senior columnist for MarketWatch. He can be reached at or at P.O. Box 70, Cohasset, MA 02025-0070.

Copyright, 2012 MarketWatch


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