What Are the Long-Term Market Prospects for Stocks and Bonds?

Portfolio Planning Article

Charles Schwab & Co., Inc.

Call us at 866-232-9890

Send us an email

Printer-friendly
Type Size: A A A
Email to a friend

What Are the Long-Term Market Prospects for Stocks and Bonds?
by Bill Swerbenski, CFA, Director, Asset Allocation and Portfolio Analysis, Schwab Center for Financial Research
Updated May 13, 2009

In the late 1990s, many investors got used to seeing double-digit returns on their investments, but that all changed with two recent boom and bust cycles of increased volatility. First, the Internet bubble grew to extreme heights only to burst with equal vigor. Then, after markets rebounded a few years later, investors were faced with even more potent double-digit losses from the current credit crisis and recession.

Markets that fluctuate to this extent make it hard for investors to plan their financial futures. A sound financial plan serves as a road map to reaching long-term financial destinations. But to get there, you need reasonable estimates of what long-term stock and bond market returns might be.

If your return estimates are too optimistic, for example, you run the risk of not being able to retire on time or pay for your children's higher education. If they're too pessimistic, you may sacrifice more of your current lifestyle than you'd like while saving for your long-term goals. Similar to the axiom "garbage in, garbage out," you can't use unrealistic assumptions to determine realistic outcomes, and this is especially true when developing your long-term financial plan.

Estimated long-term returns on stocks and bonds
To help minimize the "garbage in" aspect, the Schwab Center for Financial Research conducted a study to estimate long-term returns on stocks and bonds.

Our study shows that the average return on large-cap stocks are estimated to be about 7.4% per year in the long term (which we define to be 20 years).¹
Mid/small-cap and international stocks are estimated to return about 8.7% and 7.4%, respectively.
Bonds are estimated to earn about 3.6% per year in the long term.

These estimates are significantly below the historical returns on large-cap stocks and bonds of 9.5% and 8.3%, respectively, during the 1970–2008 time period. Of course, these are estimates of average returns—in any one year, stocks and bonds may earn far more or far less. And remember, although the future is unpredictable, it's still a good idea to plan using more reasonable return estimates.

Why are the estimates below historical averages? There are two reasons.

Our estimate of long-run inflation is 1.8%, over 2 percentage points below the actual inflation rate during the 1970–2008 time period.
Current and expected interest rates are much lower than what's transpired historically, especially compared to the high interest rate environment of the 1980s.

What you can do
So, what can you do in a single-digit return environment? Thanks to the power of compound returns, what you do today—or don't do—can have big implications for your ability to meet your long-term goals. Try to resist the temptation to do nothing in the hope that market returns will be higher than anticipated. If they are, that will be a great bonus. But it's far better to plan for a more realistic scenario.

Here are a couple of things you can do. First, while it's always wise to avoid unnecessary fees and taxes, it's even more important in a lower-return environment. Second, if you don't have a long-term financial plan, it's a good time to put one together.

The bottom line
Even though it has been an extremely rough period for the markets, stocks are estimated to provide higher returns than bonds in the long term—it’s just that the premium for investing in stocks isn't quite as high as it has been historically. Stocks, however, are still the investment with the greatest potential for long-term growth, albeit with increased risk to principal. Of course, how much of your portfolio you should allocate to stocks versus bonds depends on your risk tolerance, time horizon and liquidity needs.

1. Actual returns will vary from our estimates. For example, our estimated return for large-cap stocks during the next 20 years is 7.4% annually, on average. However, in any year the actual return may be, for example, up 25% or down 25%! Also, stocks come with more risk to principal invested than other asset classes.

Important Disclosures

Examples and estimates provided are for informational purposes only and not intended to be reflective of results you should expect to achieve. Actual results year-to-year and overall will vary and may be worth more or less than estimated value.

Fixed income investments are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, corporate events, tax ramifications and other factors.

International investing may involve greater risk than U.S. investments due to currency fluctuations, unforeseen political and economic events, and legal and regulatory structure in foreign countries. Small-cap investing is subject to greater volatility than other asset categories.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. Any investments and strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

(0509-8245)

Return to Top

Want e-mail updates?

Clients can sign up for the
Market Insight Alert

Monitor your investments' health

Schwab Portfolio Checkup®