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Moustaches

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« on: July 20, 2017, 09:56:09 AM »
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« Last Edit: August 17, 2017, 11:21:12 AM by Moustaches »

HeadedWest2029

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #1 on: July 20, 2017, 02:25:28 PM »
2.1% is certainly possible and I tend to use a modest expectations when calculating my FIRE date. Or we could be in for a more permanent low interest rate environment, in which case the P/E & CAPE aren't quite as crazy high as they appear.  https://forum.mrmoneymustache.com/investor-alley/my-problem-with-systematic-index-investing/msg974162/#msg974162


nawhite

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #2 on: July 20, 2017, 04:47:51 PM »
I definitely agree with the "interest rates will be lower going forward and thus the market will be able to support a higher P/E ratio" camp. I definitely could be wrong.

Overall I am fairly confident with an inflation adjusted CAGR of 6.8%. I.e. maintain the Inflation Adjusted CAGR the market has had from the 1890s to today.

beltim

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #3 on: July 20, 2017, 05:49:04 PM »
You're not including dividends, which immediately doubles your estimate.

GenXbiker

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #4 on: July 20, 2017, 05:59:35 PM »
You're not including dividends, which immediately doubles your estimate.
Bingo.  You beat me to it.  Also the CAGR of 2.1% of the S&P Index going from 2470 to 4606 would not be inflation adjusted, so that would amount to little gain in value if inflation is 2% per year.  So, your only real return will be from dividends, which will probably be only 1 to 2% per year:
http://www.multpl.com/s-p-500-dividend-yield/table

 

Mr. Green

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #5 on: July 20, 2017, 07:27:54 PM »
I think your CAGR data from #2 is wrong. I see it reported as 7.36%, inflation adjusted and including dividends, or 4.93%, inflation adjusted excluding dividends.

nawhite

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #6 on: July 21, 2017, 10:07:53 AM »
I think your CAGR data from #2 is wrong. I see it reported as 7.36%, inflation adjusted and including dividends, or 4.93%, inflation adjusted excluding dividends.

I agree, http://moneychimp.com/features/market_cagr.htm shows that if you include dividends, 1986 to 2016 shows CAGR at 9.07% or 7.68% inflation adjusted. That's even better than if you look at CAGR from 1871 to 2016.

patchyfacialhair

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #7 on: July 21, 2017, 10:11:12 AM »
I just use a 4% real rate of return. If it's higher, great, if it's lower, no big deal.


wenchsenior

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #8 on: July 21, 2017, 10:32:35 AM »
I just use a 4% real rate of return. If it's higher, great, if it's lower, no big deal.

Me too. We plan on a 3.5% withdrawal rate.  4% in years of unusual expenses.

runewell

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #9 on: July 21, 2017, 10:39:20 AM »
http://www.starcapital.de/research/CAPE_Stock_Market_Expectations

This site predicts US stocks will go up 3.5%/yr based on a 28 CAPE (they do some adjustments) and 3.6%/yr based on the P/B ratio.

runewell

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #10 on: July 21, 2017, 11:06:45 AM »

Interesting link, they look at what happened in the past when the US was at a 28 CAPE to predict the results going forward, and they include dividends.  I like my approach better because it uses a measure of fundamental value (Earnings Per Share - Independent Variable) and predicts that, and then calculates the price (dependent variable) based on the mean shiller PE.

But the shiller PE varies a lot over time.  It has varied between 15 and 44 in the last 20 years, and the average in the last 20 years is considerably higher than before that.  Seeing what you are doing would help me understand, but methinks that applying a mean schiller PE at the end oversimplifies things.
« Last Edit: July 21, 2017, 11:17:35 AM by runewell »

jlcnuke

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #11 on: July 21, 2017, 11:32:25 AM »
http://www.starcapital.de/research/CAPE_Stock_Market_Expectations

This site predicts US stocks will go up 3.5%/yr based on a 28 CAPE (they do some adjustments) and 3.6%/yr based on the P/B ratio.

Interesting link, they look at what happened in the past when the US was at a 28 CAPE to predict the results going forward, and they include dividends.  I like my approach better because it uses a measure of fundamental value (Earnings Per Share - Independent Variable) and predicts that, and then calculates the price (dependent variable) based on the mean shiller PE.

I think the biggest fault with such analysis is the assumption that business valuations as they were 100 years ago are as relevant as recent business valuations. Worker productivity is massively higher today than in 1917, and a thousand other things make the ability for companies to earn money today different from how they were 50, 75, 100 years ago. As such, I find that using the "total" mean Shiller PE for just about any analysis to be overwhelmingly pessimistic. If I were inclined to use it as a metric, I'd limit myself to the past 3 or so decades worth of data to most closely resemble the "new" environment we're in. 

Assuming the past limits the future doesn't seem like a great idea to me. From 1881-1990 there was only one year with a Shiller PE over 25. Using those historic numbers a similar analysis as above would have concluded there was almost no likelihood of PE ratios staying in the lower 20's for any extended period of time. If I go back to 1990 and calculate the median Shiller PE, however, I get 29.15 with only 4 years below 20.  That's not just an aberrant year or two, that's over a 28 year period - almost a full "typical retirement".

In the age of the internet and massive world connectivity, the PE ratios have been much higher than they were before most people even owned cars. I see no reason that they would have to revert to levels before an average person could afford to fly across the country going forward. If using the more recent median Shiller PE in your above discussion, the S&P 500 would be over 8,000 as opposed to ~4,600. That represents a significant change in returns and is only modifying one assumption and still staying in what has been "normal" recently, and discounting any changes to the past norms such as the more recent ability for game-changing technologies to quickly ramp up on a global scale and significant reductions in the average overhead costs to run many businesses which result in significant variances in profit margins relative to those seen throughout much of history etc.


Mr. Green

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #12 on: July 21, 2017, 11:32:34 AM »

Interesting link, they look at what happened in the past when the US was at a 28 CAPE to predict the results going forward, and they include dividends.  I like my approach better because it uses a measure of fundamental value (Earnings Per Share - Independent Variable) and predicts that, and then calculates the price (dependent variable) based on the mean shiller PE.

But the shiller PE varies a lot over time.  It has varied between 15 and 44 in the last 20 years, and the average in the last 20 years is considerably higher before that.  Seeing what you are doing would help me understand, but methinks that applying a mean schiller PE at the end oversimplifies things.

You are right, I've rerun the numbers using the minimum Shiller PE of 4.78 and got -2.1% for estimated 30 year return.  I then reran the numbers using the maximum Shiller PE of 44.19 and got 5.5% for the estimated 30 year return.  So using this model the range of returns for the next 30 years is from -2.1% to 5.5% with an expected return of 2.1%.  Seems like this is lower than what most people are assuming.
I think we would all have much larger problems than retirement to worry about if the average annual return over the next 30 years is -2.1%. That sounds like GAME OVER for our economic system to me.

Seeing a number like that, which is worlds lower than anything ever experience before, makes me question it's realistic validity.
« Last Edit: July 21, 2017, 11:34:32 AM by Mr. Green »

maizefolk

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #13 on: July 21, 2017, 11:39:41 AM »
Also, remember that your starting date for calculating earnings was before the change in accounting standards in that 90s that has essentially permanently reduced reported earnings per share (all other things being equal),* so your estimate of earnings growth is likely a significant underestimate. Looking at earnings growth from 1900-1985, the CAGR was about 4.25%

That puts earnings at about 334.40 share in 30 years, and using the same assumed PE,** a price of 5604.67, or 2.77%/year before dividends and without adjusting for inflation. Historically without dividends and without adjusting for inflation the stock market has yielded a CAGR of 4.35%, so we're talking about 1.6% slower growth than the median historical interval based on current assumptions.

* http://www.businessinsider.com/jeremy-siegel-criticizes-shillers-cape-2013-8

**But since PE is also influenced by the decrease in reported corporate earnings, my guess is that 30 years from now it will still be higher than the historical average that includes so many decades of earnings reported under the old rules.

jlcnuke

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #14 on: July 24, 2017, 09:49:21 AM »
http://www.starcapital.de/research/CAPE_Stock_Market_Expectations

This site predicts US stocks will go up 3.5%/yr based on a 28 CAPE (they do some adjustments) and 3.6%/yr based on the P/B ratio.

Interesting link, they look at what happened in the past when the US was at a 28 CAPE to predict the results going forward, and they include dividends.  I like my approach better because it uses a measure of fundamental value (Earnings Per Share - Independent Variable) and predicts that, and then calculates the price (dependent variable) based on the mean shiller PE.

I think the biggest fault with such analysis is the assumption that business valuations as they were 100 years ago are as relevant as recent business valuations. Worker productivity is massively higher today than in 1917, and a thousand other things make the ability for companies to earn money today different from how they were 50, 75, 100 years ago. As such, I find that using the "total" mean Shiller PE for just about any analysis to be overwhelmingly pessimistic. If I were inclined to use it as a metric, I'd limit myself to the past 3 or so decades worth of data to most closely resemble the "new" environment we're in. 

Assuming the past limits the future doesn't seem like a great idea to me. From 1881-1990 there was only one year with a Shiller PE over 25. Using those historic numbers a similar analysis as above would have concluded there was almost no likelihood of PE ratios staying in the lower 20's for any extended period of time. If I go back to 1990 and calculate the median Shiller PE, however, I get 29.15 with only 4 years below 20.  That's not just an aberrant year or two, that's over a 28 year period - almost a full "typical retirement".

In the age of the internet and massive world connectivity, the PE ratios have been much higher than they were before most people even owned cars. I see no reason that they would have to revert to levels before an average person could afford to fly across the country going forward. If using the more recent median Shiller PE in your above discussion, the S&P 500 would be over 8,000 as opposed to ~4,600. That represents a significant change in returns and is only modifying one assumption and still staying in what has been "normal" recently, and discounting any changes to the past norms such as the more recent ability for game-changing technologies to quickly ramp up on a global scale and significant reductions in the average overhead costs to run many businesses which result in significant variances in profit margins relative to those seen throughout much of history etc.

While I agree the internet and automation has been a gamechanger, you can't just ignore historical valuations, that is what caused the Tech bubble in the late 1990s.  If you read articles from that time period many were saying the same arguments you are making now - that due to technology you can ignore the old fuddy duddies who care about realistic earnings forecasts.

And since then the PE's have been consistently higher than the old numbers... not as high as some predicted, but consistently higher. In fact, since the early 90's, we've only reverted to the mean during the absolute worst of the most recent financial crisis and even that for only a brief period of time before quickly rebounding. So, it would seem at least the sentiment was right based on about 30 years of data... plus the whole "apples to oranges" comparison/use of numbers under the old accounting system vs new that Maizeman mentioned.
« Last Edit: July 24, 2017, 09:51:25 AM by jlcnuke »

runewell

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #15 on: July 24, 2017, 11:46:39 AM »
Also, remember that your starting date for calculating earnings was before the change in accounting standards in that 90s that has essentially permanently reduced reported earnings per share (all other things being equal),* so your estimate of earnings growth is likely a significant underestimate. Looking at earnings growth from 1900-1985, the CAGR was about 4.25%


Yes, the accounting standards changed, but when you adjust for that valuations still look high:

http://mebfaber.com/2014/01/30/what-does-siegels-nipa-pe-say-about-the-stock-market/

maizefolk

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #16 on: July 24, 2017, 03:20:46 PM »
Indeed but a lot less high. Based on the link you posted which unfortunately only goes to 2013, it looks like about half the excessive CAPE valuation is the result of changes in accounting rules. If we forecast that through to today (terrible approach but better than nothing), the current CAPE of ~30, which is about 12 points above the median historical CAPE should really be something in the neighborhood of a CAPE of 23-24. To give you a sense of how big a difference that makes:

Historically stocks have returned ~6.7%/year after inflation. In an article from earlier this year Shiller predicts real (post inflation) returns of 1% over the next decade based on CAPE. Siegel, using a different metric not influenced by the change in accounting rules predicts 5.0% returns.*

Note that folks using the 4% withdrawal rule would likely be fine in either scenario so this ultimately boils down to a bunch of handwaving.

*Source: https://www.advisorperspectives.com/articles/2017/05/23/jeremy-siegel-versus-robert-shiller-on-equity-valuations

Tyson

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #17 on: July 24, 2017, 05:36:26 PM »
Just curious, if CAPE is actually high, what do you plan on doing with your money?  Put it somewhere other than the stock market?

AdrianC

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #18 on: July 25, 2017, 08:24:55 AM »
One way of looking at it (for comparison purposes):

Real return = Dividend yield + growth rate + change in valuation

If interest rates stay low:
Real return = 2 + 2 + 0 = 4%
Nominal return with 2% inflation = 4 + 2 = 6%

Less than historical returns, but that's what you get when starting at a high valuation, and it's still not bad.

TheAnonOne

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #19 on: July 25, 2017, 08:34:39 AM »
Just curious, if CAPE is actually high, what do you plan on doing with your money?  Put it somewhere other than the stock market?

No, but it would impact my decision to carry mortgage / loans in order to invest, and the amount I have in bonds / cash.  If the break-even interest rate on debt is 2% or if it is 5% makes a big difference.

It may also be useful in determining SWR, or your lifestyle after FIRE. The 4% rule might still be used but need additional backup plans or more flexibility.

The most common response here to the high valuations is that, if you were to FIRE, TODAY, you might want to consider a 3.5% SWR. This, of course, could change in 3-6 months if we were to get a 15-25% pull back. In which case at THAT POINT IN TIME, the 4% rule might seem a little more honest.


In reality though, once you reach 25X your expenses, (the 4% rule) you are set. Not because the math on remaining 100% fixed with withdrawals will necessarily work out or not, but because the FIREie is young enough that he/she can weather changes and remain flexible.

Someone in their 70s has no option of returning to work, growing a side business, or really doing much at all. Compared to someone who is 42, with reasonably fresh job skills or time to learn them.

aceyou

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #20 on: July 25, 2017, 09:10:44 AM »
I think the market will continue to grow.  I don't understand shiller or cape but I'm just thinking in terms of opportunities.  I see opportunity for new types of energy to expand through the world.  I see automation  as an opportunity.  I see those things allowing poorer parts if the world to increase their consumer goods, which we will probably help produce.  And like it or not, our country will have to invest in maintaining our infrastructure.  And then there's all the things that don't exist yet that will become ubiquitous.  And unfortunately, it seems like our government wants to pass on most of the profits from these things to people who own companies, which will be us.

Tyson

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #21 on: July 25, 2017, 10:24:01 AM »
One way of looking at it (for comparison purposes):

Real return = Dividend yield + growth rate + change in valuation

If interest rates stay low:
Real return = 2 + 2 + 0 = 4%
Nominal return with 2% inflation = 4 + 2 = 6%

Less than historical returns, but that's what you get when starting at a high valuation, and it's still not bad.

Don't forget that market returns are often "adjusted for inflation", and mortgages are not.  Long term "real" return for the S&P500 is 10%, but you often hear people say it's actually 7%.  That's because they knock 3% off to "adjust for inflation". 

In truth, you should take 10% (real return), add the 2%(dividend re-investment) and that gives you your actual return. 

Re: invest vs. mortgage - assuming you have a 4% mortgage (or less), the math isn't even close.  You end up with way better outcomes by investing.  The ONLY way paying the mortgage pays off is if the long term return on the market drops from 10% to 2%.  Hmmm, that seems pretty unlikely. 

AdrianC

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #22 on: July 25, 2017, 10:51:22 AM »
Don't forget that market returns are often "adjusted for inflation", and mortgages are not.  Long term "real" return for the S&P500 is 10%, but you often hear people say it's actually 7%.  That's because they knock 3% off to "adjust for inflation". 

In truth, you should take 10% (real return), add the 2%(dividend re-investment) and that gives you your actual return. 

Re: invest vs. mortgage - assuming you have a 4% mortgage (or less), the math isn't even close.  You end up with way better outcomes by investing.  The ONLY way paying the mortgage pays off is if the long term return on the market drops from 10% to 2%.  Hmmm, that seems pretty unlikely.

Your numbers are off.

https://dqydj.com/sp-500-return-calculator/

1967-2017
S&P500 Nominal (not inflation adjusted) return with dividends reinvested = 9.9%
S&P500 Real (inflation adjusted) return with dividends reinvested = 5.6%

Sure, when deciding on leverage you use the nominal expected return vs mortgage rate.

dandarc

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #23 on: July 25, 2017, 10:56:08 AM »
tyort - what's your start date?  I get 9% nominal, already including dividend reinvestment if I start at the beginning, but cherry picking start-years, I get more of a range than I was expecting.  https://dqydj.com/sp-500-return-calculator/

Your larger point that in the mortgage vs. invest question you compare nominal return vs. mortgage interest rates still holds water though.  You might use 7% to estimate future stock returns because you want to be conservative (not because you're adjusting for inflation), but still a land-slide for "keep mortgage".

Tyson

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #24 on: July 25, 2017, 10:56:59 AM »
Don't forget that market returns are often "adjusted for inflation", and mortgages are not.  Long term "real" return for the S&P500 is 10%, but you often hear people say it's actually 7%.  That's because they knock 3% off to "adjust for inflation". 

In truth, you should take 10% (real return), add the 2%(dividend re-investment) and that gives you your actual return. 

Re: invest vs. mortgage - assuming you have a 4% mortgage (or less), the math isn't even close.  You end up with way better outcomes by investing.  The ONLY way paying the mortgage pays off is if the long term return on the market drops from 10% to 2%.  Hmmm, that seems pretty unlikely.

Your numbers are off.

https://dqydj.com/sp-500-return-calculator/

1967-2017
S&P500 Nominal (not inflation adjusted) return with dividends reinvested = 9.9%
S&P500 Real (inflation adjusted) return with dividends reinvested = 5.6%

Sure, when deciding on leverage you use the nominal expected return vs mortgage rate.


Yes, you are right.  Sorry about that.  But the #'s still heavily favor keeping the mortgage and investing heavily in the stock market.

Now, you might be afraid to do that because reasons.  That's fine.  If you can't stick with investing in the market during a bull market, then you probably should get out now because you'll likely panic and sell during a bear market.  And THAT is the worst possible outcome.
« Last Edit: July 25, 2017, 10:58:40 AM by tyort1 »

AdrianC

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #25 on: July 25, 2017, 06:47:37 PM »
But the #'s still heavily favor keeping the mortgage and investing heavily in the stock market.

Now, you might be afraid to do that because reasons.  That's fine.  If you can't stick with investing in the market during a bull market, then you probably should get out now because you'll likely panic and sell during a bear market.  And THAT is the worst possible outcome.
I think you're addressing the OP here, right?

Tyson

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #26 on: July 25, 2017, 06:50:34 PM »
But the #'s still heavily favor keeping the mortgage and investing heavily in the stock market.

Now, you might be afraid to do that because reasons.  That's fine.  If you can't stick with investing in the market during a bull market, then you probably should get out now because you'll likely panic and sell during a bear market.  And THAT is the worst possible outcome.
I think you're addressing the OP here, right?

It was mostly directed at Moustaches. 

beltim

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #27 on: July 25, 2017, 11:27:17 PM »
One way of looking at it (for comparison purposes):

Real return = Dividend yield + growth rate + change in valuation

If interest rates stay low:
Real return = 2 + 2 + 0 = 4%
Nominal return with 2% inflation = 4 + 2 = 6%

Less than historical returns, but that's what you get when starting at a high valuation, and it's still not bad.

Don't forget that market returns are often "adjusted for inflation", and mortgages are not.  Long term "real" return for the S&P500 is 10%, but you often hear people say it's actually 7%.  That's because they knock 3% off to "adjust for inflation". 

In truth, you should take 10% (real return), add the 2%(dividend re-investment) and that gives you your actual return. 

Re: invest vs. mortgage - assuming you have a 4% mortgage (or less), the math isn't even close.  You end up with way better outcomes by investing.  The ONLY way paying the mortgage pays off is if the long term return on the market drops from 10% to 2%.  Hmmm, that seems pretty unlikely.

I'm not convinced that the next 30 years will be just like the past 100 years and  the constant reminders of the long term return of the market of 7-10%.  The point of this analysis was to estimate the fundamental value (Earnings per share) in 30 years and then think through what that would imply to the rate of return, holding the shiller PE constant.  You can either argue that the shiller PE will be higher in the future or EPS will be higher, these are the inputs of the function, while the price is the output. 

I've just rerun the numbers assuming a 3.72% growth rate in EPS, and a 7% rate of return, and this would imply that in 2047 the shiller PE would be 68 (higher than any in history).

You forgot dividends again.

DoubleDown

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #28 on: July 26, 2017, 01:00:10 PM »
I just use a 4% real rate of return. If it's higher, great, if it's lower, no big deal.

Same here, 4% after considering inflation. I built my retirement plan such that I could withstand a far lower rate even over the long haul. Social security+pension would already provide enough "old man money" to live on when I get there, and young man money will last long enough even if returns were negative for a long time. But 4% real return seemed like a reasonable estimate.

So far I've hit the sequence of returns lottery. Actual returns have been higher than 4% since I retired in 2013, so consequently my net worth has grown non-trivially since retiring rather than going lower or just remaining stable. At this point the next, inevitable recession could not put my retirement in danger. Also I have about a 60/40 asset allocation between stocks and safe assets (cash, securities, house) so even large drops at this point would hardly make a dent. I've even upped spending a bit since it's become apparent that I likely won't be able to spend the money in my lifetime.

aceyou

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Re: What is your expected long term rate of return for the S&P 500?
« Reply #29 on: July 26, 2017, 03:04:18 PM »
I think this can be a smart decision.  Investing at the individual level isnt always about getting the highest possible expected return.  Sometimes it's better to lower you ceiling if it allows you to raise your floor.