This article has been adapted from our sister site across the pond, Fool U.K.

Surely after two bear markets and a decade of shares that went nowhere, investors who kept the faith ought to be cut some slack.

OK, so the FTSE 100 has already rallied by as much as 70% since the bear market turned bullish in March 2009. But wasn't that just been a snap back to reality from a market staring into the abyss? Isn't the universal skepticism about shares, financial companies, and the stock market a great contrarian signal for better returns ahead? Can't we (please, please, can't we?) expect a few years of 1990s-style double-digit advances a year?

Not according to Vanguard founder John Bogle.

Sorry.

Less is not more
Writing in the Financial Times, Bogle has dismissed the idea that U.S. investors can expect 9% a year from the U.S. stock market simply because that's what it delivered on average over the past century.

And where the U.S. market goes, the U.K. market will follow.

Bogle writes: "Even if we accept the belief that past market returns are an accurate representation of reality, the idea that future returns will center round the past is an illusion."

So what's Bogle's version of reality? He says that a "reasonable expectation" of nominal returns for U.S. investors over the coming decade is merely 7%.

That's not a lot of percent. I'm not sure Naomi Campbell gets out of bed for less than 10.

  • If you invested 10,000 pounds for 10 years at 7%, you'd have 19,672 pounds at the end of the decade.
  • If instead you got the 9% you might expect from the history books, you'd have 23,674 pounds.

That's already quite a difference, but the divergence gets even bigger over the long term as compound interest works its magic.

After 30 years at 7%, your 10,000 pounds has become 76,123 pounds. That's a lot less than the 132,677 pounds you'd be sitting on if you achieved a 9% return.

And the differential just gets worse and worse the longer your time horizon. After 40 years, you'd have built up less than half the pot compared to that boasted by last century's 9%-per-year investor.

No April Fool's joke
Unfortunately for optimists, Bogle hasn't plucked his 7% figure from the air, either.

He points out that the 9% a year that the U.S. market historically delivered came from a combination of roughly 4.5% from dividend yields and 4.5% from earnings growth.

With the U.S. market now yielding only around 2%, a key element of that return has been slashed in half. Hence Bogle's lowered expectation for a total return of 7%.

Still, 7% is 7% right? That's better than a kick in the teeth.

Alas, Bad News Bogle puts a damper on even this unexciting return: "These returns are conventionally measured in nominal terms, and are almost certain to overstate the painful reality for investors building long-term wealth."

Real returns -- which strip out the corrosive impact of inflation on your spending power -- are sharply lower than that implied by nominal numbers.

For instance, $10,000 invested for 50 years at 9% would have grown to $743,000.

But adjust for 4% inflation to leave real returns of 5%, and your total return after sitting in the market for half a century plunges to less than $115,000!

Costly advice
As you'd expect from the father of index funds, Bogle goes on to stress that these humdrum expectations for real returns from the stock market make it absolutely vital to keep your costs low when investing, in order to hang on to as much of your gains as you can.

If you're paying out 2% a year in fees from what's only a 5% real return, then you're going to have to shovel away absolutely enormous amounts of money to rely on the resultant 3% growth to keep you warm in your retirement.

I can't bear to do the compound-interest calculation. There's only so much reality I can take.

Do you know better than Bogle?
So is there any reason for us to be more optimistic?

Perhaps. There's no disputing that Bogle is right to encourage us to consider costs, valuation, and real versus nominal returns.

But I think I might quibble with a couple of his numbers.

It's true that the U.S. market is yielding far less than it once did, but that's at least partly because its companies are using their free cash to execute far more share buybacks instead.

I prefer dividends to buybacks as much as the next Fool (mostly), but it's surely unrealistic to simply consider the dividend yield-plus-earnings growth equation for total return. Secondly, while Bogle applies a 4% inflation rate to that 9% nominal return from the past 100 years, he doesn't say anything about future inflation.

As it happens, inflation in the developed world has been trending lower for three decades. If it averages, say, 2% a year for the next few decades, then in real terms a 7% nominal return will be just as good as that 9% nominal return in the past.

All that said, Bogle is wizened and wealthy, and he has revolutionised investing by being infinitely more realistic than Wall Street. We dismiss his warnings at our peril.

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