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Why Market Returns May Be Lower and Global Diversification More Important in the Future

Key Points
  • Market returns on stocks and bonds over the next decade are expected to fall short of historical averages.

  • The main factors behind the lower expectations for asset returns are low inflation, historically low interest rates, and equity valuations.

  • International stocks appear more attractive than U.S. stocks based on valuations, underscoring the importance of investing in a diversified portfolio.

Market returns on stocks and bonds over the next decade are expected to fall short of historical averages, while global stocks are likely to outperform U.S. stocks, according to our 2020 estimates.¹

This article provides a broad overview of the methodology used for calculating our capital market return estimates and highlights the importance of global diversification and maintaining long-term financial objectives that are based on reasonable expectations.

The main factors behind the lower expectations for market returns are below-average inflation (despite a recent rise in expected inflation), historically low interest rates, and elevated equity valuations.

The reduced outlook follows an extended period of double-digit returns for some asset classes, as shown in the chart below. As such, now may be a good time for investors to review, and consider resetting, long-term financial goals to ensure that they are based on projections grounded in disciplined methodology rather than on historical averages.

Our estimates show that, over the next 10 years, stocks and bonds will likely fall short of their historical annualized returns from 1970 to 2019. The estimated annual expected return for U.S. large-capitalization stocks from 2020 to 2029 is 6.3%, for example, compared with an annualized return of 10.6% during the historical period. Small-capitalization stocks, international large-capitalization stocks, core bonds, and cash investments also are projected to post lower returns through 2029. However, the expected annual return for international large-capitalization stocks is 6.7% over the next 10 years, which is higher than the expectations for U.S. large-capitalization stocks.

Our latest 10-year estimates are lower than what we forecasted last year. This is partly due to the stretched valuations we have seen in the equity markets and historically low yield curves observed across bond markets during 2019. We saw a strong rally of 29% in U.S. large-capitalization stocks in 2019, without a meaningful increase in forward-looking earnings forecasts, leading to compressed expected returns. U.S. Treasury yield curves were markedly lower by the end of 2019the 10-year U.S. Treasury constant maturity yield was lower by 0.9%. Given this low-yield environment, and elevated valuations, it is no surprise that expected returns are lower.

Here are answers to frequently asked questions about these market estimates:

Why are long-term estimates of returns important?

A sound financial plan serves as a road map to help investors reach long-term financial goals. To get there, investors need reasonable expectations for long-term market returns.

Return expectations that are too optimistic, for example, could mislead investors to expect their investments to grow at an unrealistically high rate. This may cause them to save less, in the hope that their investments might grow large enough to fund their retirement or big expenses. But when actual returns do not match these expectations, it could lead to a delayed retirement or make it difficult to pay for a big expense, such as a college education. On the other hand, if return expectations are overly pessimistic, too much may be saved in the nest egg at the expense of everyday living.

How do you calculate your long-term forecasts?

The long-term estimates cover a 10-year time horizon. We take a forward-looking approach to forecasting returns, rather than basing our estimates on historical averages. Historical averages are less useful, as these only describe past performance. Forward-looking return estimates, however, incorporate expectations for the future, making them more useful for making investment decisions.

For U.S. and international large-cap stocks, we use analyst earnings estimates and macroeconomic forecast data to estimate two key cash-flow drivers of investment returns: recurring investment income (earnings) and capital gains generated by selling the investment at the end of the forecast horizon of 10 years. To arrive at a return estimate, we answer the question: What returns would investors make if they bought these assets at the current price level to obtain these forecasted future cash flows?

For U.S. small-capitalization stocks, we forecast the returns by analyzing and including the so-called “size risk premium.” This is the amount of money that investors typically expect to earn over and above the returns on U.S. large-capitalization stocks.

For the U.S. investment-grade bonds asset class, which includes Treasuries, investment-grade corporate bonds and securitized bonds, our forecast takes into account yield-to-maturity of the risk-free bond, roll-down return, and a credit risk premium.² We believe the future level of returns an investor will receive is anchored to a large extent by the yield of a risk-free U.S. Treasury bond. U.S. Treasury bonds are considered to be default-risk-free. Aside from this, roll-down return is an additional source of return investors typically earn, as they almost always invest in a bond portfolio that is designed to maintain an average maturity. As prices rise when yields fall, and yields on longer maturities are usually higher than on shorter maturities, when a bond manager sells a bond whose maturity date has grown closer, this typically results in a gain. This gain is called the roll-down-return. Credit risk premium is the return an investor earns for taking on the risk of investing in a relatively riskier bond, such as a corporate bond.

Cash investments are very short-term in nature, typically not exceeding three months at a given time, and are reinvested at the end of each period for as long a horizon as desired. We assume this horizon to be 10 years, and estimate the returns from cash investments over this period.

Why do you expect long-term returns to be lower than historical averages?

Three primary factors are behind the forecast for reduced returns: lower inflation, low interest rates, and equity valuations.

  • Low inflation. Inflation averaged 4% annually from 1970 to 2019. Our inflation forecast comes from consensus estimates of leading economists. This is expected to average 2.2% from 2020 to 2029, about the same as last year. When the rate of inflation is low, bond yields also have been low. That is because bond investors generally do not require as much yield premium to compensate for the erosion in buying power that inflation can inflict on a portfolio. For stocks, low inflation historically has meant low nominal (before inflation) returns. Nominal returns are the actual returns earned by investors, before adjusting for inflation.
  • Low interest rates. Lower inflation generally means low nominal interest rates. Nominal interest rates are the actual interest rates earned by investors, before adjusting for inflation.) This affects yields on everything from cash to 30-year Treasury bonds. Our rate forecast over the next 10 years is 2.6%, down from 3.4% last year, for U.S. investment-grade bonds—as reflected by the Bloomberg Barclays U.S. Aggregate Bond Index—as we believe we will continue to see low interest rates relative to history. By historical standards, we are also in an era of low real rates (i.e., rates after adjusting for inflation) and this is likely to continue because the consensus forecast for global economic growth is much lower. Low yields mean investors earn less from the fixed-income portion of their portfolios.
  • Equity valuations. Valuations appear to be stretched compared to last year’s levels. While earnings growth is expected to remain stable in the medium term, the 2019 stock rally has run far ahead of these expectations. Consensus forecasts of economic growth over the long term remain lackluster, which prompts us to remain cautious and to forecast returns that will be lower than their historical averages. The 2019 rally in U.S. large capitalization stocks (29%) was far more pronounced than in international large capitalization stocks (18%), leading to valuations outside U.S. to be less elevated, despite international stocks’ relatively lower earnings expectations. High stock prices today, without a proportionate increase in future earnings, means lower expected returns going forward. But stocks still tend to have higher expected returns than bonds, as they generally have higher risks.

  Curb your expectations and consider going global

Total return = price growth plus dividend and interest income. The example does not reflect the effects of taxes or fees. Numbers rounded to the nearest one-tenth of a percentage point. Benchmark indexes for the asset classes: S&P 500® index (U.S. Large-Cap Stocks), Russell 2000® (U.S. Small-Cap Stocks), MSCI EAFE Index® (International Large-Cap Stocks), Bloomberg Barclays U.S. Aggregate Bond Index (U.S. Investment-Grade Bonds), and Citigroup 3-Month U.S. Treasury Bill Index (Cash Investments). Past performance is no guarantee of future results.

Source: Charles Schwab Investment Advisory, Inc. Historical data from Morningstar Direct. Data as of 12/31/2019.

What could lead to higher returns?

Returns could exceed our expectations if the U.S. economy grows more than economists anticipate. According to consensus forecasts, economists expect 2% annual gross domestic product (GDP) growth over the next 10 years. Higher-than-expected economic growth would likely lead to higher earnings growth, driving stock and bond returns higher. An example of the economy growing faster than expected occurred from 1990 to 1999. During that period, economists expected annual GDP growth of 2.4%, while the U.S. economy actually grew at a much higher rate of 3.2% annually on average. Corresponding returns from U.S. large-capitalization stocks were 18.2% on average and core bonds averaged 7.7% despite severe market turbulence in 1998.

Why do you expect international stocks to outperform U.S. stocks?

As shown in the chart above, U.S. large-capitalization stocks are expected to return 6.3% annually over the next 10 years, compared to 6.7% for international large-capitalization stocks. This is mainly due to the valuation differences between U.S. stocks compared to international stocks. Our expectation of the relative outperformance is 0.4%.

What can investors do now?

Thanks to the power of compound returns, what investors do (or don't do) today can have big implications on their ability to meet their long-term goals.

Here are a few things to consider doing. First, if you don't have a long-term financial plan, now is a good time to put one together. Second, try to minimize fees and taxes, particularly in a lower-return environment. And last but not least: Build a well-diversified portfolio.


1 Charles Schwab Investment Advisory, Inc., a separately registered investment advisor and an affiliate of Charles Schwab & Co. Inc., annually updates the capital market return estimates.

Treasury notes generate what is considered a “risk-free” rate, or yield, because of the negligible chance of the U.S. government defaulting on its debt obligations. A corporate credit “risk premium” is the amount of money that investors expect to earn above and beyond the yield because of the chance of a default by the corporation that issued the bond.

What You Can Do Next


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Important Disclosures:

All forward looking statements contained in this release, including any forecasts and estimates, are based on Charles Schwab Investment Advisory’s outlook only as of the date of this material. Charles Schwab Investment Advisory, Inc. (“CSIA”) is an affiliate of Charles Schwab & Co., Inc. (“Schwab”).

Investing involves risk including loss of principal.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. Data here are obtained from what are considered reliable sources; its accuracy, completeness or reliability, however, cannot be guaranteed.

Past performance is no guarantee of future results.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

International investments are subject to additional risks such as currency fluctuation, geopolitical risk and the potential for illiquid markets.

Small-cap stocks (or securities or investments) are subject to greater volatility than those in other asset categories.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixedincome investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.

Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. For more information on indexes please see

Source: Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). BARCLAYS® is a trademark and service mark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Bloomberg or Bloomberg’s licensors, including Barclays, own all proprietary rights in the Bloomberg Barclays Indices. Neither Bloomberg nor Barclays approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

Charles Schwab Investment Advisory, Inc. ("CSIA") is an affiliate of Charles Schwab & Co., Inc. ("Schwab," Member SIPC).


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