There have been a lot of predictions from professionals lately about what kind of returns we can expect on our investments, and it doesn’t look good. In June PIMCO's bond guru Bill Gross announced at the Morningstar conference that a close-to-zero interest rate was the “new neutral.” Gross envisions a market where bonds return just 3% to 4% a year on average, while stocks return a modest 4% to 5%.
Gross’s forecast echoes that of a number of other investment
experts who called this post-Recession era we are in “the boring years,” during
which investors are likely to earn returns of just 3% for bonds and 4% for
equities.
These low-return predictions are based, in part, on
diminished expectations for the U.S. economy, with the IMF recently
warning that our GDP growth may get stuck at 2% for the long term unless
Washington adopts significant reforms.
A 4% return would be a huge decline from the historical
performance of the U.S. stock market, which has earned an average annual 10%
over the last 40 years. Many financial planners still use 8% to 10% as the
expected return for stocks in 401(k)s and other investment portfolios. All of
which presents a real predicament for those of us in the middle of our careers
who have been assuming strong growth will carry us over the finish line.
The real benefit of starting to invest early, the reason
people in their 20s are exhorted to open retirement accounts, has always been
the power of compounding in the last 10 or so years of a 40 year horizon—the
hockey stick uptick on a line graph. But in order to experience that
exhilarating growth curve, you need to earn an average annual return in the
high single digits, not the low single digits. Compounding simply doesn’t have
as much power if you start off earning 10% for 20 years and then earn only 4%
for the second 20 years.
If these predictions come true, it will be much more
difficult to make money off of money in the future. This will impact just about
everybody age 40 or older: current retirees and people living off fixed
incomes, those hoping to retire in five to ten years, and those in mid-career
who will need to rethink their strategy moving forward.
The only real solution is to save more and spend less. You
can try to earn more, but another strange feature of this
recovery-that-doesn’t-feel-like-a-recovery is that while unemployment has
dropped, wages have remained stagnant. Besides, depending on your tax bracket,
you would have to earn a lot more to get to the same amount after taxes that
you could put aside by saving.
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