Why Investment Returns Could Be Low for Decades

The S&P 500 (SNPINDEX: ^GSPC  ) is effectively flat over the last 12 years. That reality has seriously hurt investor confidence and left retirements accounts around the world dangerously underfunded.

And here's the scary part: It could be like this for years to come.

Last week, I sat down with Robert Arnott, CEO of Research Affiliates and one of the most influential investment minds of the last decade. In his view, three forces could contribute to dismal returns: demographics, debt, and deficits. He calls it the "3D hurricane." 

Here's what else he had to say about investment returns (transcript follows):

Morgan Housel: We've just been through a decade of essentially zero returns in the stock market. We have bond yields today that are effectively guaranteeing low, if not zero or negative, future returns. Do you think we are in the "new normal" world of low returns going forward?

Robert Arnott: Absolutely. We term it a little differently. We call it the "3D Hurricane" -- the interconnected influence of deficit, debt and demography -- and that's part of the new normal. The other part of the new normal is low yields. If you're in a low-yield environment, you're in a low-return environment. If you're in a low-growth environment, you're in a low-return environment. And low returns aren't in and of themselves dangerous. What's dangerous is the expectations gap. If people are expecting 10% from stocks and they get 4%, horrible, horrible things happen to their plans. If they're expecting 4% and they get 10%, they'll have planned for the worst, and it didn't happen. And 4% ... I think is probably a not-unreasonable expectation for stock returns over the next 10 to 20 years. Four percent in and of itself is not a horrible rate of return. It's 4% better than you get through the bank.

Morgan Housel: So about 4% real from let's say the S&P 500.

Robert Arnott: I would say 4% nominal [before inflation].

Morgan Housel: Four percent nominal, so maybe 1% to 2% real [after inflation].

Robert Arnott: Correct.

Morgan Housel: Is that over the next decade, the next 30 years?

Robert Arnott: The next 10 to 20 years, yes. Now that's from current levels. If levels correct to lower levels, then I would ratchet my expectations up from there.


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  • Report this Comment On December 19, 2012, at 2:07 PM, ClimbinFool wrote:

    Morgan,

    I always enjoy your articles, but your opening sentence I feel is somewhat disingenuous. Sure the S&P is effectively flat over the last 12 years. It's also doubled since 2009, or down 8% from 2007, or up 70% from 2003.

    I feel the convenient 12 year data point is only useful for those investors who suffered a coma in 2000 and woke up today.

  • Report this Comment On December 19, 2012, at 3:53 PM, TrojanFan wrote:

    I have to disagree with drfrank1.

    I think Morgan's remark is a useful illustration of just how volatile returns in the equity markets actually are, which investors are often far too sanguine and dismissive about.

    The fact that you can find ANY 12 year rolling period in the data history for this asset class that produces a flat return should give one pause. The fact that it happens to coincide with the LAST 12 years from a starting point of today is even more unsettling.

    In the information age in which we presently live and the 10 second attention span that accompanies it, it's important for any financial author to have a "hook" to kick off the piece to grab the reader's attention. I don't mind if Morgan throws in a little shock value. People should be shocked.

    If I'd told you or anyone else for that matter in the height of the "we can do no wrong" tech euphoria of 2000 that yours or anyone else's return on their large cap equity index funds over the next year would be flat to negative you would have laughed at me. If I told you they'd be flat over 12 years you would have thought I was crazy and that I needed to be commited.

    Turns out it was investors and the pack behavior they engage in that was actually crazy.

    I see similar pack behavior happening in the high yield bond market today where I principally work and I find it gravely concerning. It's as if that market didn't learn a single lesson from 5 years ago.

    That pack behavior, incidentally, is intrinsically linked to the low yield environment that Morgan's discussing here. There is lots and lots of blind yield chasing going on right now and it's not going to end well.

    It's not so much the absolute yields that are concerning, it's the anemic yield spread to comparable duration treasuries that is alarming and the covenant lite deals that are being ferociously brought back to market and met with equally ferocious demand. The compensation that a high yield bond investor receives today for their investment is inadequate to sufficiently cover the risk of inflation, stastical probability of defautl and probable loss given default and still leave a reasonable profit.

    Now if treasuries carried negative nominal interest rates in sympathy with what I believe to be negative REAL interest rates at present (particularly in light of the dismal state of European public finance and the linkages that ongoing and seemingly endless slow motion catastrophe is going to have with the rest of the global financial system once it starts unraveling in earnest), then the tight nominal spreads on high yield bonds might be considered justifiable on a relative basis, but that's obviously not the case.

    Only Switzerland and Denmark to my knowledge have gotten serious about adopting negative interest rate policies to my knowledge. You can make a theoretical argument that the balance sheet augmentation the FED is engaging in with its various incarnations of quant easing constitue a negative interest rate policy, but I think actual negative yields on those securities would be more a more potent policy tool and more representative of the actual macroeconomic backdrop which no one in official policy setting circles want to admit.

    Rather than an abrupt and somewhat violent rebalancing, but very efficient in terms of the time consumed to achieve that rebalancing they have opted for a very slow motion state of suspended animation by setting floors under asset prices. That may make people feel better psychologically and it's certainly more politically palatable, but it means it's going to take forever and a day to work through the overhang caused by the excesses of the last cycle. I'd say it's going to take so long, in fact, that we'll be sure to be hit with another recession (and a fresh wave of excesses that come with it) before we've even finished working through the last one.

    That may feel good, but it's not good policy. Discipline almost always involves pain and discipline is what's missing here.

  • Report this Comment On December 19, 2012, at 4:18 PM, Darwood11 wrote:

    The title of the article could be "there is no easy money."

    On the other hand, with dividends included, life isn't all that difficult for investors. For example, my Quicken quick and simple "gain and loss" indicator shows about 1/2 of the actual gain of my investment portfolio. That includes cash allocated to that bucket, stocks, bonds and mutual funds.

    Why is that? Well, for example, it shows a net loss for NFLX of 38%. But I sold a substantial position before this stock "tanked." That amount was greater than my actual cash investment. So what I currently hold is pure profit.

    My point is that some of these statistics are overly simplistic. We supposedly have passed through a decade of no gain, and yet, with about 1/3 of my portfolio allocated to carefully selected companies that provide a dividend, and a careful selection of bond fund, I've done rather well.

    And I'm carrying a substantial percentage of my portfolio as cash (about 20%).

    However, I do appreciate Arnott's point and the article.

    My point? One of my financial hobbies is to track the alleged predicted return from specific portfolios. I have several over at M* and that includes Motley Fool RYR model portfolios as well as my actual portfolio. A few years ago the predicted long term return for my portfolio was 7-9%. Today that same portfolio is predicted to achieve about 5.3%.

    Am I in trouble? No. I used 4.5% as my expected return from tax-deferred accounts for planning purposes. Other accounts are at 1.0% long term for planning, but I've used a range of 0.1 to 1.0% in my "what if" models.

    My point here is that given what we currently know, and the tools available, Arnott's low returns as in "lower than the historical highs" is probably realistic. My other point is that when one is planning on returns from investments and making retirement plans, it's probably wiser to anticipate returns lower than the sometimes stellar stuff quoted in the media.

  • Report this Comment On December 19, 2012, at 4:24 PM, Darwood11 wrote:

    I need to correct my post. If I include my cash accounts, those of my spouse and those of my closely held business, I'm about 34% cash.

    That's a bit excessive, but it's not prudent for a business to invest cash in the stock market. My spouse and I are rather conservative (ages 56 & 66) and so we have that kind of a mindset.

    If our ages were 26 & 36 it would be different. But, as they say "it is what it is."

  • Report this Comment On December 19, 2012, at 4:49 PM, TMFCrocoStimpy wrote:

    What often gets left out of the analysis of the S&P 500 are the dividends. If you look at the index with dividend reinvestment (e.g., SPY) then the last 12 years produce an annual return more like +2.5-2.6%%. Not stellar, but it does give a cumulative return of nearly 36% over that time period.

    Mr Arnott's point is well taken that we will see a diminished level of returns compared to what we have come to expect, but I have to wonder if he included dividends in his estimate of 4%

  • Report this Comment On December 19, 2012, at 6:54 PM, Darwood11 wrote:

    I suspect he did not include dividends in his 4% estimate. Over at M*, Arnott gave an interview on August 9 and he stated "For U.S. equities we have anemic growth in the years ahead. We have a relatively anemic dividend yield of 2%. That's not a formula for great returns. Our estimate is that during the next 10 to 20 years, stocks will give us 4% to 6%." In the same article he made reference to "U.S. equities we have anemic growth in the years ahead. We have a relatively anemic dividend yield of 2%."

    Mr. Arnott is preoccupied with "deficit, debt, and demography" which means higher taxes in the U.S., in his view.

  • Report this Comment On December 19, 2012, at 7:04 PM, NickD wrote:

    Companies that sell soap and stuff and collect trash and sell coffee did just fine

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