Author Topic: 5% return after inflation - optimistic, conservative or probably close to real?  (Read 6756 times)

Allen

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Question is in the title.  If someone assumes a 'real' return of 5% after inflation in the stock market, are they being optimistic, conservative or probably close?

I'm hoping it's conservative.

pzxc

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Well, the most common formula is the 4% SWR (safe withdrawal rate) which inherently assumes 4% real return after inflation (7% nominal return, 3% inflation).

So the answer to your question is "optimistic" if you're talking about a 30+ year timeline.

AccidentalMiser

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I think it's conservative from an expectation perspective and optimistic from a planning perspective.

beltim

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Well, the most common formula is the 4% SWR (safe withdrawal rate) which inherently assumes 4% real return after inflation (7% nominal return, 3% inflation).

So the answer to your question is "optimistic" if you're talking about a 30+ year timeline.

That's not why a SWR is 4%.  The SWR is specifically lower than expected stock market returns for a number of reasons, perhaps the most important of which are:
1) The stock market does not increase monotonically, so having a SWR lower than the expected real returns protects against "sequence of returns" risk basically, the risk that the stock market goes down in the early portion of your retirement.
2) The average retiree portfolio has a significant holding of bonds, which in the long term have significantly lower returns than stocks.

Question is in the title.  If someone assumes a 'real' return of 5% after inflation in the stock market, are they being optimistic, conservative or probably close?

I'm hoping it's conservative.

The long term (100+ year) average annual returns of the US stock market are about 7% real (a little less than 10% nominal, a little less than 3% inflation).  These data are available from a plethora of sources.
http://en.wikipedia.org/wiki/Stocks_for_the_Long_Run
http://www.simplestockinvesting.com/SP500-historical-real-total-returns.htm

If you think the future is not as bright as the past, you can adjust your expectations for future returns.

Luck12

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I wouldn't expect more than 4% real returns.  Future doesn't look bright IMO. 

sirdoug007

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This website lets you look up the Compound Annual Growth Rate (CAGR) of the S&P500 over whatever period you like.

http://www.moneychimp.com/features/market_cagr.htm

"The most significant pattern is this:

Over the very long run, the stock market has had an inflation-adjusted annualized return rate of between six and seven percent."

I'd say 5% is conservative for long periods (>15 years).  Over short periods, anything can happen.

Remember the 4% rule is based on the WORST year to retire in the last ~85 years.  In most years 4% is very conservative. 

For projections I like to use 6.5% real to try to be in the right ballpark.  It doesn't matter too much though because the returns will be what they will be.  Nothing I can do about it. 

CPA CB

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A 5% return in the long haul would dictate approximately 6.5-8.5% NOMINAL returns per year, on average, in perpetuity...

I think the answer here is - it depends.

Are you managing your own money, and making prudent picks from a fundamental analysis standpoint? Then sure, this is possible. If you're investing with a mutual fund and 'investment advisor' then this is going to be a real challenge to hit.

Good luck!



Allen

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That covers the return pretty well, but what about the assumption of 3% inflation?  The monkey with the inflation numbers all the time.  Is 3% REAL inflation where my REAL purchasing power is degraded 3% a year optimistic, conservative or about right?

Jessa

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That covers the return pretty well, but what about the assumption of 3% inflation?  The monkey with the inflation numbers all the time.  Is 3% REAL inflation where my REAL purchasing power is degraded 3% a year optimistic, conservative or about right?

I assume 5% returns on my investment and 3% increases on my expenses. Covers all bases. Probably more conservatively than necessary.

waltworks

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File under "out of my control and besides stocks are a pretty good inflation hedge".

-W

That covers the return pretty well, but what about the assumption of 3% inflation?  The monkey with the inflation numbers all the time.  Is 3% REAL inflation where my REAL purchasing power is degraded 3% a year optimistic, conservative or about right?

Grateful Stache

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Speaking of which...

Why do folks who index worry about inflation? Don't index funds represent current market prices, including inflation?

Sorry if this is off topic.

Cheers!

frugal_c

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What is your time period?  The longer your investment horizon the more realistic this is.   If you are not planning to need the money for 30 years then I would say absolutely it's realistic.  If you are planning to retire in 5 or 10 years then I would say no.

Sid Hoffman

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I wouldn't expect more than 4% real returns.  Future doesn't look bright IMO.
I think it's important to recognize that every country has two economies: the economy that big businesses operate in, and the economy that 100% of the population lives in.  While I think there's risk of income stratification for the population, that is kind of irrelevant to big businesses.  Wal-Mart makes a ridiculous amount of money from people who have no money.  How?  They accept EBT (Food Stamps).

Big businesses get and stay big by making sure they are making money no matter what.  That's where there's a fair amount of safety investing in mid to large-cap companies and their associated bonds.  These are companies which have proven their ability to succeed regardless of what else is going on in the economy.  I think that is likely to continue into the future and that 4% will still be fairly safe.  Like others have said, make it 3.5 or 3% if you want to be extra safe.

MooseOutFront

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I use 5% real in my estimates.  I do not view this as conservative, nor do I view it as optimistic.  So, just about right imo.  Dr. Bernstein would say to use something closer to 4% using some compelling arguments about the past 100 years of US investing being an anomaly as the single best time and location for investment in the history of the world, and thus would recommend tempering expectations of this continuing into the long term future.  Dave Ramsey wants you counting on 12% so that compound interest is exciting to think about.

I feel good about my personal ability to mitigate official inflation numbers, so I feel safe enough planning on 5%.  I honestly expect it will exceed that considering my asset allocation choices and low fees.  But 5% feels right for planning purposes.
« Last Edit: November 07, 2014, 01:44:11 PM by MooseOutFront »

sirdoug007

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I came across this figure a while ago from A Random Walk Guide to Investing and love how it presents expectations for market returns.  Note this is not adjusted for inflation.

In the short term, who knows.  In the long term, the market will increase nicely.


RichMoose

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Question is in the title.  If someone assumes a 'real' return of 5% after inflation in the stock market, are they being optimistic, conservative or probably close?

I'm hoping it's conservative.

A 5% real rate of return would fall in the range of close to a little on the conservative side for an investor that heavily tilted to low-fee stock index funds and is investing for at least 20 years without selling. There is a lot of evidence out there to support this and personally I think it's a good number to use. I've read in a few reputable places that the real rate of return on US stocks is 6.5 - 7.5% including dividends. However, off of that comes management fees, taxes (if not in a special account), and that sort of thing.

Just make sure you don't double account for inflation. If you use 5% real for your investment, don't add to your expenses because you are already assuming that inflation is accounted for.

DarinC

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It depends on your timeline. It can be very low, a real ~0+%, over the course of a decade, but over the course of 2-3 decades is a real ~4-6% historically.

Eric

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I wouldn't expect more than 4% real returns.  Future doesn't look bright IMO.

Are you planning an associated lower withdrawal rate then?  ~2%?

Eric

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I'd say that a 5% real return from a diversified international portfolio is pretty conservative, and I'm personally expecting higher returns.