What’s a reasonable return to expect from your portfolio?
Clients – especially those new to the investing world – may be expecting more than the market can deliver.
Investment researchers at Vanguard think a balanced portfolio with a 60% stock/40% bond allocation will have returns below long-run historical averages over the next decade, probably falling in the range of 3%–5% per year, adjusted for inflation.
Their reasoning? Subpar economic growth, near zero interest rates, and disappointing productivity all play a role.
The problem is that if you ask your typical investor, they might say they expect 10-12% or more per year.
Why the disconnect?
Many investors have limited investment experience. They generalize based on what they’ve seen in recent years. That could lead them to expect too little of the market (like many millennials, who shun the market in favor of overly safe investments) or too much (like newer investors who underestimate stock market risk, not having experienced a serious pullback in several years). Investors with more real-life market experience usually have more moderate expectations. They’ve been around the block a few times and realize that markets are cyclical.
Some investors have forgotten the importance of diversification. In recent years, large U.S. stocks – those making up the S&P 500 Index – have beaten out other asset classes, leading many novice investors to want to overweight U.S. stocks in their portfolio. The problem is, all good things come to an end. Today’s top performer could easily end up at the bottom of the heap by tomorrow.
That’s why it’s important to diversify and include out-of-favor asset classes in your portfolio. It’s not smart to own just the “best” performers. Several investment advisers recently interviewed by the Wall Street Journal complained that many clients have “unrealistic” expectations for their portfolios. Advisers report spending considerable time fending off clients’ demands to put more money into U.S. stocks than the advisers feel is appropriate. It’s hard not to see some parallels to 1999.
They neglect the math behind calculating portfolio returns. Portfolio returns are simply the weighted average returns of the various portfolio components. That means that if your stocks return 10% and your bonds return 2%, your overall return – in a balanced portfolio – will be 6%. Inexperienced investors get hooked on what the S&P 500 did. But you don’t own just the S&P 500.
The S&P 500 is reflective of only a relatively narrow slice of the investment world. If your portfolio is well diversified, and includes global, small cap and the typical broad range of stocks, bonds and alternatives, your overall return will be a weighted average of those different investments.
They forget that the best advice is to hope for the best, but save for the worst. In other words, don’t count on outsized portfolio returns to save your bacon and meet your retirement and other life goals. Periods of outperformance and market calm are great, so enjoy them while they last. Just don’t expect them to last forever. They could easily be followed by cycles of rocky or disappointing returns.
And remember that the one thing you should expect from the market – is the unexpected.