Tuesday, June 7, 2016

The 8% Return Assumption Will Not Die

June 7, 2016
Bloomberg: A Simple Recipe for the 50-Year Investor

A portfolio allocated 50 percent to the S&P 500 and 50 percent to five-year U.S. treasury notes has returned 8 percent annually since 1926 (including dividends).

The 5-year Treasury currently yields 1.22%. Should that continue, stocks would have to earn 14.78% per year to make up the difference. At these lofty valuations, good luck on that.

(I concede that neither U.S. stocks nor bonds are priced to provide that kind of return today, but I think the long term average is a useful gauge for what’s likely to happen over multi-decade periods.)

Classic denial. More interested in the rear-view mirror than the view out the front window. Concedes that stocks and bonds aren't priced for 8% returns, yet has faith that we can still count on 8% returns over the long run. That historical mirror is just so enticing.

The 30-year Treasury currently yields 2.53%. If you buy today, you know exactly what you will be getting over the next 30 years. There is no room for debate. The bond market doesn't care about what once was. It cares about what is and what will be. In order to hit the 8% target with an equal mix of stocks and bonds, stocks would need to return 13.47%. Once again, good luck on that.

Further, bond yields have been falling for nearly 40 years. To ignore that fact and instead use data going all the way back to 1926 can best be described as wishful thinking. Ask the Japanese about bond yields after their massive housing bust. They'll tell you. It isn't pretty.

As more and more money is deposited in banks, that money has an increasingly difficult time generating real returns. This isn't rocket science.

October 8, 2015
WSJ: Big Banks to America’s Firms: We Don’t Want Your Cash

The developments underscore a deepening conflict over cash. Many businesses have large sums on hand and opportunities to profitably invest it appear scarce. But banks don’t want certain kinds of cash either, judging it costly to keep, and some are imposing fees after jawboning customers to move it.

8% returns over the long-term? I am incredibly skeptical. Inflation could someday do it I suppose, but we won't like the results. Few investors look back at the 1970s and think it was an investor paradise.

Want scary?

April 6, 2000
Risk and Risk Control in an Era of Confidence (or is it Greed?)

All of these statistics leave me apprehensive. Why? Because the future is not only unknown but unknowable. Yet with the acceptance of Modern Portfolio Theory; the ease of massaging data with the computer; and our existence (at least in the U.S.) in today's era the of remarkable political stability combined with powerful economic growth, investors seem to have developed growing confidence that they can forecast future returns in the stock market. If you fall into that category, I send you this categorical warning: The stocky market is not an actuarial table.

To which I add: When everyone assumes, at least implicitly, that the market is an actuarial table, that the past is inevitably prologue, and that common stocks, held over an extended period, will always produce higher returns than bonds and at lower risk then stocks inevitably will be priced to reflect that certainty. At that point, however, the certainty becomes that stocks will produce lower future returns, and at higher risk at that. It is impossible to escape the suspicion that such an actuarial mindset, if you will, is extraordinarily prevalent today among investment advisers, consultants, and economists and, for that matter, the individual and institutional investors themselves. Forewarned is forearmed.

SPY, adjusted for splits and dividends, has returned an average of 4.1% per year since April 6, 2000. There is no telling what it will return over the next 16 years. Seriously.

I do have a fairly good grasp what the I-Bonds I purchased in April of 2000 will do though. 3.4% over inflation, every year, like clockwork. They mature in 2030, 14 years from now. No rear-view mirror needed. Barring an apocalypse default scenario, they pay what they pay. Every month they hit a new record high, not that you will ever read a headline saying that. Unlike the stock market, they can never fall in value. Go figure.


dearieme said...

Good grief, you got a 30 year bond paying 3.4% real?

We once owned bonds paying 4.5% real, but our mean old government issued them with just a five year life. Boo!

I can remember the Personal Finance Editor (or maybe his deputy) of the Financial Times saying that those were a better bet than equities. I dare say he was about to retire. Whether he knew it or not.

mab said...

Should that continue, stocks would have to earn 14.78% per year to make up the difference.

8% is like the so called constant "c" (regardless of reference frame) in physics and all the foolishness that follows from it. That said, if you buy into the 8% assumption, stocks are a screaming buy.

Stagflationary Mark said...


I have another batch of 3.4% I-Bonds purchased in 2001. Then the economy had a little boo-boo. Sigh.

Stagflationary Mark said...


186,000 miles per second. It's not just a good idea, it's the law!

8% returns. It's not just a good idea, it's the underfunded pension plan law!