Tuesday, March 01, 2005

Is 10% Realistic...Part II - The Economists

In a previous blog I mentioned that I didn't feel that the historical return we have enjoyed on stocks would continue in the future, however I also noted that I have no idea if I will be right - only time will tell. I mentioned that over the past 200 years "real" returns (return after inflation) averaged about 6.5%, this translates to about a 10% return including inflation. Recently the Wall Street Journal ran an article on Social Security and asked several prominent economists to weigh in on what they believe real returns will be over the next 44 years. What follows is the response:

Name Organization Stocks Gov. Bonds Corp. Bonds

William Dudley Goldman Sachs 5.00% 2.00% 2.50%
Jeremy Siegal Wharton 6.00% 1.80% 2.30%
David Rosenberg Merrill Lynch 4.00% 3.00% 4.00%
Ethan Harris Lehman Bros. 4.00% 3.50% 2.50%
Robert Shiller Yale 4.60% 2.20% 2.70%
Joseph LaVornga Deutsche Bank 6.50% 4.00% 5.00%
Paul Jain Nomura 4.50% 3.50% 4.00%
John Lonski Moody's 4.00% 2.00% 3.00%
David Malpass Bear Stearns 5.50% 3.50% 4.25%
Jim Glassman JP Morgan 4.00% 2.50% 3.00%

There you have it, the experts forecasts of returns for the next 44 years. Keep in mind that economists are known for having the best jobs in the world, they are wrong most of the time, yet continue to recieve a paycheck. I do think though that the above economists, while not being fortune tellers are not far off. The most bullish estimate is that we will continue to have 6.5% real returns on stocks, while the lowest estimate is 4.00%. The lesson here is not that we should take everything economist say to be fact, but that it is unreasonable to think that future returns will resemble the past.

In this world of lower returns there are only a few things individuals can do to ensure that they earn all the return that they can. The first is to find superior stock pickers - unfortunately that is unrealistic (see my earlier blog on luck/skill). The four things an investor must do to ensure they earn as much of the future returns as possible are:

1.) Diversify across large, small, growth, value, & international stocks
2.) Keep mutual fund & advisory expenses low
3.) Don't attempt to time the markets - stay invested through thick and thin
4.) Stay away from Active Management

If you do these four things you will greatly increase your odds of earnings all the future returns possible. In all likelihood you will outearn your neighbor who is chasing money managers, jumping in and out of stocks, and paying enormous fees to advisors who have no clue what they are doing.

To conclude this segment - expecations are everything...going forward there is a great likelihood that returns will be lower and you need to do everything possible to plan for this scenario.

Till next time.....