Vanguard Chief Global Economist Joe Davis shares what his team projects as a realistic return over the next decade for a balanced portfolio—meaning one comprised of 60% equities and 40% fixed income investments—which at 4 to 4.5% is below historical averages. As he explains, the Vanguard Economic and Market Outlook for 2019 anticipates some variance in performance in U.S. versus non-U.S. markets, as well as fixed income vs. equities–underscoring the importance of periodic rebalancing and maintaining a diversified portfolio.
Other highlights from this webcast
- Should we anticipate a recession in 2019?
- What does Vanguard predict about interest rate hikes and near-term inflation?
- How might tariffs affect the U.S. and Chinese economies this year?
- How does Vanguard develop the Vanguard economic and market outlook (VEMO) and measure its accuracy?
Rebecca Katz: Well, you know, this means now I have to put you on the spot with the next question, which is from Joseph in Connecticut, who says, “So what is a realistic rate of return for the financial markets over the next decade?” Say for a balanced portfolio, for example.
Joe Davis: Balanced portfolio. So let’s just say, just for sake of argument, you had a 60% stocks diversified portfolio and 40% fixed income. So if you’re taxable, it could be munis or if you’re in a retirement plan, it could be more of a corporate total bond market index. Our expectations there for the next 5 years are roughly 4% to 4.5% for that portfolio. That’s the average. Who knows what the pattern will be along that. It’s below historical averages for bonds, but our forecast is close to what’s your current yield to maturity. If you go into vanguard.com, that’s not always the case, but it was the case this past year and it is the case going forward that the state of maturity, the yield to mature in that portfolio is, loosely speaking, for conservative funds, our expected return. That’s not what we do and how we model it, but that’s how the math works out.
On the equity side, it’s below historical averages. It’s below what the trailing 5-year returns are generally speaking for most, certainly for U.S. investments.
For overseas, emerging markets, certainly for Europe and Asia, we’re projecting higher returns than what have been for the past 3 or 4 years. When you net that all together, you get a modest return that’s above inflation, roughly 4% or 4.5%.
If you ask me what am I assuming personally, Joe Davis from Malvern, Pennsylvania? That is the numbers. That’s the central tendency. And then planning around that. So that’s what all that says.
Rebecca Katz: It’s interesting, though, because if cash is yielding 2.5% or 3% if interest rates rise and then you have a 4% balanced portfolio, cash is not a bad return.
Joe Davis: That is. It’s a lower expected return environment. Ironically, the only thing that will lead us to markedly higher expected returns is actually a bear market because the market will sell off, but it will start to discount a future rate now.
So do I wish for a bear market?
Rebecca Katz: No.
Joe Davis: Certainly not, but I’m just telling you what will have to transpire.
Rebecca Katz: We’ll take slower growth.
Joe Davis: So my parents may be watching tonight, and they may be trying to generate 5% from their portfolio over time. Mom and Dad, I mean, there’s no Magic 8 Ball. You either can take more risk, if one is willing to do it, to eke out a higher return. It’s more equity volatility, unfortunately. Or it is spend less, or save more. I mean they’re the 3 variables that one can choose to pull in some combination. I wish I had better news, but we talked about this time last year, Rebecca, it was going to be more of a patient environment and one that was going to be a little bit frustrating because we’re not going to have the returns that we have had over the past several years.
Rebecca Katz: Right, so control the things in your control.
Joe Davis: It’s getting a little bit better for fixed income. So I’m not here to spin. If we want one solace of positive news, for the first time in 10 years since we’ve been doing this outlook—the first time—our 10-year projected returns did not become lower. Actually, they tweaked up modestly positive, previous year.
Rebecca Katz: For fixed—
Joe Davis: No, for the whole portfolio.
Rebecca Katz: Oh, okay.
Joe Davis: Because we’ve been consistently downgrading our forecast because valuations and the performance in the market’s been strong, and they’ve been ahead of the fundamentals slightly over the past 4 or 5 years, that’s why we got more guarded and more guarded but not bearish. The first time this year we did not downgrade—our computer models did not downgrade the forecast for the next 10 years. So although we see unpredictability ahead and volatility picking up, we are not getting more alarmist or more bearish in our longer-term forecast.
Rebecca Katz: That’s, again, the most optimistic I can get from you sometimes, Joe. That’s great.
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Investments in bonds are subject to interest rate, credit, and inflation risk. Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets.
IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time.
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