Robert Veres, editor of the Inside Information financial-planning newsletter, recently asked his subscribers to estimate long-term future stock returns after inflation, expenses and taxes. Several dozen leading financial advisers responded. Although some didn’t subtract taxes, the average answer was 6%. A few went as high as 9%.
Historically, inflation has eaten away three percentage points of return a year. Investment expenses and taxes each have cut returns by roughly one to two percentage points a year. All told, those costs reduce annual returns by five to seven points.
So, in order to earn 6% for clients after inflation, fees and taxes, these financial planners will somehow have to pick investments that generate 11% or 13% a year before costs. Where will they find such huge gains? Since 1926, according to Ibbotson Associates, U.S. stocks have earned an annual average of 9.8%. Their long-term return after inflation, fees and taxes is under 4%.
All other major assets earned even less. If, like most people, you mix in some bonds and cash, your net return is likely to be around 2%.
The Wall Street Journal asked several investing experts what guaranteed net return they would accept to swap out their own assets. William Bernstein of Efficient Frontier Advisors would take 4%. Laurence Siegel, a consultant and former head of investment research at the Ford Foundation: 3%. John C. Bogle, founder of the Vanguard Group of mutual funds: 2.5%. Elroy Dimson of London Business School, an expert on the history of market returns: 0.5%.
In exchange for a basket of 51% global stocks, 26% bonds, 13% cash and 5% each in commodities and real estate the institutional trading desk at one major investment bank was willing to offer a guaranteed rate, after fees and inflation, of 1%.
With relatively safe returns in double digits, that makes cash flow notes even more appealing.
