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Are Lower Investment Returns on the Horizon?

You don’t need to be a statistician to want to know the odds. In fact, it’s downright prudent for investors to understand what their stocks, bonds and cash investments are likely to return in the coming decade. Expect too much and you could miss your goals. Expect too little and you might needlessly sacrifice in the present—or, worse, take unnecessary risks in search of bigger rewards.

So, how do you know what to expect from your investments—and can past performance help you anticipate the future?

“Returns over the next 10 years are likely to be significantly lower than those we’ve enjoyed in the recent past across asset classes,” says Jim Peterson, chief investment officer of Charles Schwab Investment Advisory (CSIA). “Investors should take that into account when making their financial plans.”

At the start of every year, Jim and his team assemble a forecast of returns for major asset classes over the next decade, based on economic and interest-rate outlooks and current bond and stock valuations. Their most recent report walks investors through the reasons to be cautious.1

Specifically, U.S. large-cap stocks are expected to return an average of 6.7% annually from 2017 through 2026, counting dividends and share-price appreciation, while investment-grade bonds are expected to return just 3.1%.

Those forecasts are down dramatically from what investors earned in the past, says Veerapan Perianan, a senior quantitative analyst at CSIA. In fact, the average annual return on U.S. large-cap stocks is expected to be one-third lower than in the previous three decades, and investment-grade bonds are expected to return less than half of what they did in the past.

Cash investments are expected to provide especially paltry rewards—just 1.9% on an annualized basis over the next 10 years (in line with inflation), versus 5% annually for the period going back to 1970. This is probably no surprise to investors, who have seen money-market accounts and short-term deposits pay vanishingly low rates since the Great Recession.

Meanwhile, U.S. small-cap stocks are expected to earn an average annual return of 7.5% in the coming decade, according to Schwab’s forecast, and international large-cap stocks are expected to earn 6.9%. While the projected returns on U.S. small-cap stocks are very much in line with the decline in U.S. large-cap equities, the drop for international stocks is far less. That’s partly because their valuations haven’t risen to the same degree, Jim says, and so have more room for gains. Their returns are now expected to be slightly higher than those of U.S. large-cap shares in the coming decade—a departure from historical norms (See “Not-so-great expectations,” below). 

Not-so-great expectations

Returns during the next decade are expected to be significantly lower across all asset classes.

A comparison of annualized returns for major asset classes, for 1970-2016, and forecast returns for 2017-2027

Source: Schwab Center for Financial Research, with data from Morningstar. Benchmark indexes for asset classes are: the S&P 500® (U.S. large-cap stocks), the Russell 2000® (U.S. small-cap stocks), the MSCI EAFE® (international large-cap stocks), the Bloomberg Barclays U.S. Aggregate (U.S. investment-grade bonds) and the Citigroup 3-Month Treasury (cash investments). Past performance is no guarantee of future results.

What’s responsible for these diminished expectations? Jim and Veerapan cite four broad trends:

1. Sluggish economic growth. The U.S. economy grew 2.6% in 2015 and just 1.6% in 2016—and, despite the recent uptick in consumer confidence, economists see that somewhat sluggish rate of growth persisting. For example, Veerapan’s forecast is based on an annual rate of growth in gross domestic product (GDP)—the total dollar value of all the goods and services produced within a country’s borders—of 2% to 2.5% in the coming decade, compared with an average annual rate of 3.1% from just after World War II through last year.

How does that square with President Trump and Treasury Secretary Steven Mnuchin’s assertion that the U.S. can reach an annual rate of GDP growth closer to 3% to 4% with the help of tax reform and reduced banking regulations? Veerapan suggests a wait-and-see approach. If the recovery picks up steam and begins to show signs of persisting, a change in investment expectations might be justified. In the meantime, “we try not to react to near-term noise,” he says. “We’re looking at the long run here.”

2. Anemic interest rates. In the face of subpar growth in recent years, central bankers around the globe have kept benchmark rates at or near zero—and even experimented with negative interest rates—in an attempt to stimulate their economies. Even though the Federal Reserve has begun to reverse this stance, historically low rates will likely linger, justifying modest expectations for bond yields in the coming decade.

3. Lower inflation. Inflation may have averaged about 4% annually since 1970, but it has been much lower in recent years, and Veerapan anticipates annual price gains closer to 2% for the foreseeable future. “Low inflation is very much a contributing factor to diminished expected returns for both stocks and bonds,” he says. For stocks, which are forward-looking, returns tend to be depressed when low inflation suggests slow growth, while bond investors require less yield to counteract inflation’s effects.

4. High stock valuations. The final factor shaping CSIA’s forecast is that U.S. stocks have rallied with few interruptions since 2009, so “prices are marginally on the high side,” Jim says. Ironically, this encourages investors to pile into the market precisely when they should be most cautious. “The general behavioral trend is for investors to jump in after they’ve seen markets rise—at which point they’re probably too late,” Jim says. “Stocks may continue to climb for a while, but on average they are likely to record weaker long-term gains.”

Adjusting your expectations

The best plan of action is to prioritize your long-term goals over short-term performance, rather than attempt to anticipate the market’s inevitable ups and downs. And of course the expectation of slimmer gains in the coming decade makes it more important than ever to pay attention to fees and taxes, Jim says, which can needlessly eat away at returns in the best of times.

Perhaps the most central point, however, is this: By being realistic about expected returns, you’re more likely to develop an investment strategy that gets you closer to your objectives—even when that means tempering the optimism that comes from the second-longest bull run in American history.

1Veerapan Perianan, “Why Market Returns May Be Lower in the Future,” schwab.com, 03/13/2017.

What you can do next

  • Given Schwab’s long-term investment return expectations, it’s more important than ever to focus on your goals and develop a plan to achieve them.
  • Get help creating a financial plan and a diversified portfolio with Schwab Intelligent AdvisoryTM or talk to a Financial Consultant.
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Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment 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.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

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Schwab Intelligent Advisory™ is made available through Charles Schwab & Co., Inc. (“Schwab”), a dually registered investment adviser and broker-dealer. Portfolio management services for Schwab Intelligent Portfolios™ are provided by Charles Schwab Investment Advisory, Inc. (CSIA), a registered investment adviser. Please refer to the disclosure brochures for details about Schwab Intelligent Advisory. Free credit balances are swept into deposit accounts at Charles Schwab Bank (“Schwab Bank”). Brokerage products and accounts are offered by Schwab, Member SIPC. Deposit and lending products are offered by Schwab Bank, Member FDIC and an Equal Housing Lender. Schwab, CSIA, and Schwab Bank are affiliates and are subsidiaries of The Charles Schwab Corporation.

Please read the Schwab Intelligent Advisory™ disclosure brochures for important information.

Investing involves risk, including loss of principal.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Investment value will fluctuate, and bond investments, when sold, may be worth more or less than original cost. Fixed income securities are subject to various other risks, including changes in interest rates and credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors.

High-yield bonds and lower-rated securities are subject to greater credit risk, default risk and liquidity risk.

International investments involve additional risks, including differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

Past performance is no guarantee of future results.

Indexes are unmanaged, do not incur fees or expenses, and cannot be invested in directly.

The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry group representation.

The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index, representing approximately 10% of the total market

capitalization of that index. It includes approximately 2,000 of the smallest securities, based on a combination of their market cap and current index membership.

The MSCI EAFE (Europe, Australasia, Far East) Index is a free-float adjusted market capitalization index designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. It consists of 22 developed market country indexes: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom.

The Barclays U.S. Aggregate Bond Index is a market-value-weighted index of taxable investment-grade fixed-rate debt issues, including government, corporate, asset-backed and mortgage-backed securities, with maturities of one year or more.

The Citigroup U.S. 3-Month Treasury Bill Index measures monthly total return equivalents of yield averages that are not marked to market. The 3-Month Treasury Bill Index consists of the last three three-month Treasury bill issues.

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