Return Expectations

Bill Parrott |

Growing up, I was a picky eater and tried to limit my intake to peanut butter sandwiches, chips, and M&M's. It worked for several years, but I needed to expand my palate as I grew older. My expectations for fruits and vegetables were low, but I began to appreciate more refined foods as I grew older.

Investment returns are abysmal this year as inflation rises to a 42 - year high. As inflation soars, so do interest rates forcing stocks and bonds to retreat. The S&P 500 is down 22.5%, its worst performance since the Great Recession in 2008, and investors expect further weakening.

Focusing on year-to-date returns is depressing, especially since stocks have fallen significantly. If we step back from the daily moves, we get a better picture of the long-term returns from stocks. Here is an extended view of S&P 500 returns.[1]

  • Three-Year Return: 24%
  • Five-Year Return: 44%
  • Ten-Year Return: 157%
  • Fifty-Year Return: 3,280%
  • Seventy-Year Return: 15,210%

Since 1926, the S&P 500 has generated an average annual return of 10.2%, long-term government bonds returned 5.3%, cash has gained 3.2%, and inflation averaged 3%. Let's explore expected returns using historical data.

  • 100% stock allocation: If you allocate all your money to stocks, your expected return is 10.2%, and after subtracting inflation, your net return is 7.12% (10.2% - 3% = 7.2%).
  • 100% bond allocation: If you allocate all your money to bonds, your expected return is 5.3%, and after subtracting inflation, your net return is 2.3% (5.3% - 3% = 2.3%).
  • 100% cash allocation: If you allocate all your money to cash, your expected return is 3.2%, and after subtracting inflation, your net return is 0.2% (3.2% - 3% = 0.2%).

Allocating all your funds to one asset class does not make sense, so let's explore a few asset allocation models using the same historical data.

  • 70% stocks and 30% bonds: The expected return is 8.73%, and the net return is 5.73% after inflation.
  • 60% stocks and 40% bonds: The expected return is 8.24%, and the net return is 5.24% after inflation.
  • 50% stocks and 50% bonds: The expected return is 7.75%, and the net return is 4.75% after inflation.
  • 40% stocks and 60% bonds: The expected return is 7.26%, and the net return is 4.26% after inflation.
  • 30% stocks and 70% bonds: The expected return is 6.77%, and the net return is 3.77% after inflation.

A diversified portfolio owns large, small, and international stocks, short, intermediate, and long-term bonds, and it may hold an alternative asset class like real estate. In a diversified portfolio, one investment is always down; if there isn't, the portfolio is not diversified. We must apologize for at least one asset class that loses money each year. A typical Wall Street saying is, "Diversification means always having to say you're sorry."

Warren Buffett's holding period is forever, and that's why he is worth $100 billion. He does not get rattled when stocks fall and has said, "Be greedy when others are fearful." When we build portfolios, we choose the most prolonged time horizon possible for our review to account for various economic and market cycles. Sometimes, the data goes back more than a hundred years, and we're not concerned with daily, weekly, monthly, or yearly returns because we think generationally.

A financial plan is a vital component for successful investors, and it will quantify your goals and determine your asset allocation. During difficult economic times, we encourage our clients to follow their financial plans and not lose sight of their goals. If your financial plan is working, there is no need to abandon it or your investment portfolio.

Here are a few suggestions to help you with your investments.

  • Think generationally.
  • Expand your time horizon when reviewing your portfolio.
  • Follow your plan.
  • Rebalance your accounts.
  • Don't panic.
  • Buy the dip.

As markets oscillate, focus on your financial goals because your future self will thank you.

What the hell is a gigawatt? ~ Marty McFly, Back To The Future

October 20, 2022

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM's custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren't suitable for every investor.



[1] DFA Matrix Book and Returns Web