Some investors may be frustrated with the low returns they’ve experienced over the past 10 years.
And with concerns over high stock valuations and rising inflation, some are worried future returns could be even lower.
Is it time to do something different?
Not so fast.
Putting “Low Returns” in Perspective
Past returns are not as bleak as some would have us believe.
Let’s look at returns from 2007 to 2017, during which the S&P 500 grew at an annualized rate of 8.5% per year.
While lower than the historical average of 10.3% per year for all decade-long periods, it’s important to note each of these return figures are nominal. They don’t account for inflation.
While nominal returns are important, what determines an investor’s real purchasing power are real returns— returns after stripping out inflation.
After factoring in inflation—which has been historically low, as well, over the past 10 years—real returns have been quite average. In fact, after adjusting for inflation, returns for the S&P 500 have been 6.8% per year over the past decade.
The historical 10-year average? 6.8%.
So, while nominal returns have been low, the purchasing power of those returns has been in line with what investors have earned over the course of history.
But what about future returns? Do today’s high stock valuations and the risk of higher inflation mean low returns will extend into the future?
While no one knows what markets will deliver tomorrow, we believe there is reason for optimism.
Purchasing power is what matters
Over the past 10 years, annualized inflation has averaged a historically low 1.6%.
Moving forward, investors’ collective estimate of inflation, based on the breakeven yield between 10-year nominal Treasury bonds and Treasury inflation-protected bonds, is indeed higher at 2.1%.
But if the market’s consensus estimate is correct, future inflation will still be much lower than the historical average decade-long rate of 3.3% per year.
That’s potentially good news for investors. If the fear of lower nominal returns turns out to be true, the real purchasing power of those returns may still be attractive relative to history.
High valuations can mean attractive returns
Valuations for large cap U.S. stocks are relatively high. But over the course of history, high valuations have generally led to lower future returns, not negative returns.
Consider three past periods of peak valuations for the S&P 500: The Great Depression, the Vietnam War, and the Tech Bubble.
In the 10 years that followed these valuation peaks, the S&P 500 delivered a cumulative 54%, 84%, and 36%, respectively.
History shows that high valuations can still mean attractive returns for disciplined investors.
Maintain a more balanced perspective
Keep in mind that the chatter about high valuations applies primarily to large cap U.S. stocks. While an important component of any diversified portfolio, large cap U.S. stocks are just one slice of the pie.
Globally diversified investors maintain exposure to multiple asset classes, such as small cap U.S., international, and emerging market stocks, which are nowhere near as highly priced.
In other words, these lower-priced parts of a portfolio may just be the engines of portfolio growth over the next decade.
The Long View on Returns
While the future is inherently uncertain, we remain confident that a well-diversified and regularly rebalanced portfolio is the best way to protect and grow wealth over the long run.
By remaining invested, keeping a lid on costs, and driving down taxes, investors can harness whatever returns markets are generous enough to offer.