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Expectations

Posted:October 14, 2016

Categories: Asset Allocation, GMO, Investing, Markets

Every four years we elect a new President. Every four years the most gifted athletes in the world compete in the Olympic Games. I don’t know about you, but this election cycle is driving me crazy! So why don’t we talk about the Olympics instead. Meet Clayton Murphy. Just 21 years old, Murphy earned a bronze medal in the 800 meters this past summer in Rio. It was the first time an American has medaled in the 800 meters since 1992. He finished in a time of 1:42.93, which was the third-fastest American time ever and faster than his previous personal record time of 1:44.30. He was an improbable bronze medal winner. Murphy’s goal coming into the Olympic Games was to simply make the final. Murphy commented after the race,

“I don’t know if (winning a medal) ever was a reality,” Murphy said. “The big goal I had was making the final. A medal for me was going to be icing on the cake. I just wanted to have fun with it, and enjoy the minute and 40-some seconds I was out on the track. You never know how many times you’re going to run in the Olympics. It’s super exciting.”
 

Murphy’s expectations were to make the final, certainly not to medal! And certainly not finish behind 0.78 seconds behind David Rudisha, possibly the greatest ever to run the 800 meters. There was a study done on Olympic athletes showing that bronze medalists are quantifiably happier than silver medalists. It all boils down to expectations. Here is what their research discovered:

“Silver medalists tended to focus on how close they came to winning a gold medal and so they weren’t satisfied with silver. Bronze medalists were focused on how close they came to not getting a medal at all! So they are thrilled with the bronze medal. They are happy to be on the medal stand at all.”
 

Expectations for Future Capital Market Returns

The story of Clayton Murphy should be a lesson to all investors. Be careful with your expectations, especially as it relates to expected returns from your portfolio. Ask many individuals what their expectations for returns from the stock market are in a given year and most people respond with a number between 8 to 10% per year. Many pension funds, endowments and insurance companies rely on actuarial assumptions of 7%+ for their portfolios in order to meet their expectations for future liabilities. And keep in mind, their portfolios are not 100% stocks! Can our capital markets produce such returns looking forward? I think the simple answer is no.

First, let’s frame this discussion with looking at historical returns for capital markets.

  • Stocks have produced an annual return of 9.4% over the past 116 years.
  • Bonds has produced an annual return of 5% over the past 116 years.
  • Blended together at a 60/40 mix and you get an annual return of 7.6%.
  • Over the past 10 years, a 60/40 blend has returned 7% annualized.
  • Over the past 5 years, a 60/40 blend has returned 11% annualized.

Many prominent investors and institutions have argued recently for lower future capital market returns. From Vanguard to Bill Gross to Rob Arnott, future market returns look abysmal when compared to historical returns.

Future Expected Returns 2016 10

The simple average of these predictions center around 4% for a balanced portfolio of 60% stocks and 40% bonds. While these projections span slightly different time frames and use slightly different benchmarks, the message is clear: Expect lower returns in the future for stocks and bonds.

Investment Implications

Investing can be very emotional. One way in which investors can keep their emotions in check is to set proper expectations for future returns on their portfolio. For a younger investor, expect 4-6% for an all stock portfolio instead of 8-10%. For an investor nearing retirement, expect 3-4% for a balanced portfolio instead of 6-8%.

Planning Implications

Proper expectations can greatly help as you plan for retirement and ultimately drawing down your portfolio.

  • For those still saving for retirement, strive to save more than you otherwise planned allowing the power of compounding to help in a low-return world.
  • For those nearing retirement, possibly look to work a little longer or bridge the gap to retirement with part-time work or supplement with other sources of income such as rental or business income.
  • For those in retirement, watch your annual expenses as well as the percentage you are drawing out of your investment assets each year. A good benchmark is try to draw around 3% or less per year from your investment assets.
  • For all investors, align your portfolio asset allocation to your specific goal (college, retirement etc.).

In a recent sermon at National Community Church, Lead Pastor Mark Batterson suggested the following:

“Your focus determines your reality. It is not your objective circumstances, it is your subjective expectations that determine how you feel and how you think and how you make decisions and how you live your life.” 
 

Setting proper expectations in our financial lives can go a long way in determining not only how we set and achieve goals, but how we feel and react along the way.

References

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