Investing decisions should always be made in the context of your overall financial plan. And although we know short-term forecasts are futile, a retirement plan needs to include some assumptions about returns and risk over the long term. To help with this important task, my colleague Raymond Kerzérho, PWL Capital’s director of research, has just updated our white paper, Great Expectations: How to estimate future stock and bond returns when creating a financial plan.
As we explain in the paper, there are two main approaches to estimating future stock returns. The first is to rely on a historical premium: over the last 50 years, stocks have delivered returns of about 5% above inflation, so one could simply expect that to continue. The second approach raises or lowers that expected premium depending on whether stocks are currently undervalued or overvalued. You can apply similar methods to expected bond returns, using either the long-term premium (about 2.7% over inflation) or the current yield on a benchmark index.
Both methods are flawed, but an average of the two is likely to be a useful estimate.