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Are 10% Returns a Pipe Dream?

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It used to be financial planning gospel: If you invested in stocks, you could count on an average return of around 10% annually over the long haul. But as many investors have discovered over the past decade, the long haul is sometimes longer than you can wait -- and if you don't plan for a potential shortfall on those returns, you can get left high and dry by an unexpected bear market.

So given how badly stocks have performed since the 2000 peak, is it time to give up on the chase for 10% annual returns? Is the "new normal" a world of lower returns, or is the recent underperformance merely a prelude to another period of outpaced gains in the future?

The law of averages
That's one topic that this month's brand new issue of Rule Your Retirement tackles. In the newsletter, which you can read today at 4 p.m. ET, Fool retirement expert and financial planner Robert Brokamp invited research analyst and SMU senior fellow Ed Easterling to talk to the service's subscribers about whether investors should count on history repeating.

In the interview, Easterling shares some data from his recent book, Probable Outcomes. One particularly interesting analysis looks at how returns over various 10-year periods throughout the 20th century compare to the average. As you'd expect, roughly half of those periods have returns of less than 10%, while the rest have returns of more than 10%.

What's surprising, though, is just how spread out those returns can be. Despite the 10% average, only 22% of the time did returns fall within 2 percentage points of that 10% figure. In contrast, you were much more likely to see either annual returns of more than 12% or less than 8% than to hit the middle of the target.

That may make planning seem like a hopeless cause. After all, the difference between an 8% return and a 12% return over 10 years amounts to almost 100% of what you initially invest by the end of the period.

Play the cards you're dealt
As hopeless as that may sound, Easterling points to some clues to help guide your planning. He observes that poor-returning periods typically start when stock market valuations are high, while stronger returns come with lower valuations. And with high P/Es and low dividend yields, he believes now is a period of high valuations, which suggests weak performance ahead.

Some would argue with Easterling's conclusion, however. Generalizing about the overall market obscures the fact that there are two distinct trends going on beneath the scenes. On one hand, high-flying stocks such as salesforce.com (NYSE: CRM  ) and Sigma Designs (Nasdaq: SIGM  ) have triple-digit trailing P/Es. Those multiples reflect expectations of soaring growth in the near future, but they also leave the stocks vulnerable to corrections if lofty expectations turn out to be unrealistic.

At the same time, many large-cap bellwethers have much more reasonable valuations. Microsoft (Nasdaq: MSFT  ) , Hewlett-Packard (NYSE: HPQ  ) , and AT&T (NYSE: T  ) have seen their P/Es compress to around 10 or less. And although these companies all face uncertainties about their future prospects, they nevertheless don't reflect an overheating stock market.

Also, while dividend yields are historically low, companies aren't paying out as much of their earnings in dividends as they typically do. With huge earners Apple (Nasdaq: AAPL  ) and Google (Nasdaq: GOOG  ) unwilling to pay anything to investors in dividends, it's tough to draw comparisons against periods during which nearly all stocks gave something back to shareholders.

Hope for the best, expect the worst
Of course, it's impossible to know for sure whether the next decade will bring a return to the domination of stocks or continue in the footsteps of the lost decade. What you can do, though, is to have a contingency plan for whatever the future may bring. That's where Rule Your Retirement can really help, not just with analysis in the current issue but also with seven years of valuable resources that will show you how to make the perfect financial plan for you. And full access to everything the subscription service has to offer is just a click away with a free 30-day trial.

Counting on 10% returns is a recipe for heartbreak if you run into a tough market. That doesn't mean that a comfortable retirement is a pipe dream. It just means you have to take steps to protect yourself from worst-case scenarios. If you do that, you'll find success in the long run.

Get started with a 30-day trial of Rule Your Retirement today -- it's free and there's no obligation to subscribe.

Fool contributor Dan Caplinger has plenty of pipe dreams, and they occasionally even come true. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Apple, Google, and Microsoft. Motley Fool newsletter services have recommended buying shares of AT&T, Microsoft, Apple, salesforce.com, and Google; creating a bull call spread position on Apple; creating a diagonal call position on Microsoft; and shorting salesforce.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is anything but average.


Read/Post Comments (2) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 02, 2011, at 2:04 PM, ukgold wrote:

    It all depends what sort of investment goals you have just to be a "passive" investor then maybe 10% is unattainable, but if you have a core of strong investment and are will to do some "leg work" to look at different types of stocks /commodities ETF's.. if you can short as well as just being "long" then then min I would look for is 20/25% return per year

    LTBH does does not work, you need to be pro-active as its is YOUR MONEY

  • Report this Comment On June 02, 2011, at 4:03 PM, LivingInReality1 wrote:

    Actually I can get at least a 25% return on my investment and do it in less than a months time. Would it be legal . . . . nope . . . but it can be done. 10% might be a bit unrealistic for legal ventures but 5-7% is easily obtainable and if you have the right timing and luck you can make a bundle pretty fast.

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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