What Kind of Returns Do You Expect?

Have you thought about what type of returns you need in order to retire?  Or to put your kids through school?  Now that you’ve thought about what you need, what do you expect?

Bill Gross wrote his monthly piece about this issue.  It was titled, “Cult Figures.”  Here are some interesting (that’s a euphemism for “depressing”) thoughts that I took from Gross:

1. Over the REALLY long run (e.g., the last 100 years), stocks have outperformed bonds.  Stocks have given us a “real return” (i.e., above inflation) of 6.6%.

2. Over the shorter (more recent) term, Treasury bonds have outperformed stocks.  In fact, Treasuries outperformed stocks for the 30 years ending 2011.  Of course, it’s unusual to think of less risky securities outperforming riskier securities.

3. During the past 100 years, we had real GDP growth of 3.5%.  So, if we’re producing 3.5% more goods and services (in real terms), it’s strange to think that shareholders are profiting 6.5% in real terms.

4. With stocks growing at a faster rate than the economy, this means that shareholder wealth is growing (relative to the economy).

5. If the economy grew at 3.5% for the past 100 years (in real terms), it makes sense that bondholders would earn slightly less than this and stockholders would earn more.  When you’re splitting profits, the people who took the most risk should earn more.

6. But, this idea that shareholders earned so much more (6.6% vs. the real GDP growth of 3.5%) can’t simply be justified by the idea that stocks are riskier than bonds.

7. Another significant reason is that when you look at how GDP has been divided, capital providers have been rewarded while labor and government have lost share.  Real wages and salaries were 53% of GDP approximately 40 years ago.  Today, they are closer to 44%.  In addition, the share of GDP that has gone to corporate taxes has also decreased (as rates have decreased during this time period).  See his chart below.

8. You can’t expect the 6.6% real rate of return (for stocks) to continue.  Real growth will be slower.  Labor is going to need some recovery.  Certainly, the government is going to start to take a bigger percentage of GDP.

9. You also can’t expect high returns from bonds.  When bonds started their bull run, they were yielding over 14% in 1981.  Today, the ten-year Treasury is near 1.5%.  The Barclay’s U.S. Aggregate Bond Index (a composite of investment grade bonds and mortgages) yields 1.8% with an average maturity of 6 – 7 years).

10. If we have a nominal return of 2% for bonds and 4% for stocks, we’re looking at pretty low returns.  And remember, now Bill Gross is talking about nominal returns (nominal returns = real returns + inflation).

11. “If financial assets no longer work for you at a rate far and above the rate of true wealth creation (Gross is referring to real GDP growth as “the rate of true wealth creation”), then you must work longer for your money, suffer a haircut on your existing holdings and entitlements, or both.”

12. The only way that we’ll get to higher yields is if we try to inflate our way out of our problems.  But realize that 8% yields due to 6% inflation is still just a 2% real rate of return.

Have a great week.

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