If you think the stock market is the road to a comfortable early retirement, you're wrong. You may have thought about cashing in on the long-term average annual returns of 7% (post-inflation) you heard you could get from investing in stocks, but I'm here to tell you to think again.
That long-term average likely won't happen year in and year out. In fact, you will have long periods of over- or underperformance. For example, in the past decade, the SPDR S&P 500 ETF (NYSE: SPY ) , an exchange-traded fund (ETF) designed to track the broad U.S. stock market, returned an amazing 1.5% per year. That includes income from dividends. That's a long way from 7%.
It's a small, small world
Going global helped a bit, as the iShares MSCI EAFE Index Fund (NYSE: EFA ) -- a proxy for the world's non-U.S. developed markets -- has provided a total annual return of 6.1% since it was started just over nine years ago.
But for the tantalizing returns generally associated with stock markets, investors had to rely on emerging markets, which provided annual returns of 12.8% over the past 10 years.
It could be worse
However, according to Jeremy Grantham, co-founder of asset management firm GMO, even this limited outperformance is coming to an end. He and his team of analysts are expecting emerging-market stocks to return just 4.7% per year after factoring in inflation over the next seven years. U.S. large-cap stocks are expected to return a measly 0.3% after inflation, and U.S. small-cap stocks are expected to lose almost 2% per year over that period.
Now this is only one man's (and his associates') view, but when Grantham speaks, people in the financial world listen, because over the years he has proven incredibly prescient when it comes to long-term investment returns, fairly accurately calling the annual rates of return on 11 asset classes between 2000 and 2010.
Change is in the wind
If Grantham is right, we could be in for what many commentators are calling the new normal, meaning that the broad-based market joy that we experienced 1983 to 2000 will be reserved for history books. Instead, we could be in for several years of volatile markets that generally move sideways.
In this type of market, index funds and ETFs won't do your portfolios any favors. Buy and hold just won't do it. Investors will need to be much more discerning and proactive if they expect to see the types of returns that will lead to an early retirement.
Investors who know how to pick the stars from the wannabes will be able to take advantage of the volatility that is characteristic of this new type of market.
That means finding high-quality companies with secure dividends, companies like Waste Management (NYSE: WM ) and Johnson & Johnson (NYSE: JNJ ) , both of which have strong market positions and stable cash flows to support their 3%-plus dividend yields.
Megacap blue chips like these are well-followed by both Wall Street and Main Street, so we wouldn't normally expect them to blow the doors off the market, but things aren't normal. Times of market volatility provide opportunities to snatch up these stalwarts at discount prices, and the safe dividend provides a source of income while you weather uncertain times.
Looking in the dumps
And while we may not see markets move up much over the next several years, there will be movement within markets by stocks that are currently being shunned for whatever reason.
Dramatic changes taking place in the health-care industry are giving investors plenty of reasons for shunning. As the populations of the developed world age, health spending is rising as a share of GDP, and a lot of that is government spending. When those governments are looking to trim their budgets without shrinking the social safety net, the logical conclusion is that health-care providers will feel the pinch. Add to that the raft of blockbuster patented drugs scheduled to go off patent in the next few years, and the prognosis for the industry doesn't look all that good.
However, within the industry there are going to be companies that benefit from the growing demand for their products. Device manufacturers like Medtronic (NYSE: MDT ) will see a growing market for their existing products as people live longer, and the company's heavy investment in research promises to keep innovative products coming.
The rise of generic drugs may be bad news for traditional Big Pharma companies, but it is great news for companies like India's Dr. Reddy's Laboratories (NYSE: RDY ) , which manufactures inexpensive drugs for both developed and developing markets. In fact, Dr. Reddy's has teamed up with GlaxoSmithKline (NYSE: GSK ) as part of the latter's effort to build its presence in emerging markets. As part of a broader acceptance that the Big Pharma business model is likely dying, Glaxo has been partnering with or acquiring emerging-market drug makers to make sure it doesn't miss out on this relatively less profitable, but rapidly growing piece of the global pharmaceutical market.
Each of these companies has its own strategies in place to help it recover from the health care industry's current afflictions. This means that investors with the patience to ride out the current uncertainty should be rewarded down the road.
Don't go it alone
That's what Jeff Fisher and the Motley Fool Pro team do -- troll the depths of market sentiment to find investments that perform even in a volatile market. They even take it one step further, using tools like options to pick up investments at bargain prices or produce income even as stock price stagnates.
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