by David Novak
What a wild year 2016 was for the stock market. Who would have believed in
early February, after the worst start to the year for the stock market ever, and with potentially jolting outcomes of the United Kingdom’s Brexit vote and the U.S. presidential election still ahead of us, that we would finish the year with the S&P 500 Index up 12 percent and the Dow Jones Industrial Average closing in on 20,000? I certainly wouldn’t have.
I can’t remember the market being this optimistic in a very long time, probably
not since the technology stock bubble of the late 1990s (and that euphoria was largely
concentrated in a single economic sector). Just this week it was reported by the
National Federation of Independent Business that the small business optimism index
hit a 12-year high in December, the biggest one month gain since 1980.
One of the most challenging aspects of investing is not becoming a prisoner of
the moment—i.e. allowing yourself to get too optimistic or too pessimistic based
on current events. Investors have a way of extrapolating the current situation out
indefinitely into the future. In the credit crisis of 2008 through early 2009, there
were real questions being asked about the banking system collapsing and taking the
entire stock market down with it. Managing and preventing clients from allowing the
extreme short-term volatility to make a long-term mistake with their portfolio was
not always easy.
Along those lines, I thought it would be instructive to consider what some of the
respected bellwethers in the financial industry expect returns to be over the coming decade. Let’s start with Calpers, the state of California’s public pension system which manages more than $300 billion in assets, making it the largest public fund in the U.S. As a pension fund which is responsible for covering more than 1.7 million current and future retirees, in theory Calpers has an infinite time horizon. Its long term rate of return assumptions are used to determine the amount of money required to fund the plan.
Last month Calpers reduced its overall rate of return expectation from 7.5 percent
to 7 percent. While this may not sound like much, the effect of one half of one
percent compounded over decades on hundreds of billions of dollars is significant.
Or one could consider Jack Bogle, the founder of Vanguard and one of the most
respected figures in the entire financial services industry. In a September interview
with Morningstar, Bogle noted that he expected 4 percent average annual long-term
returns for stocks, and 2.5 percent average annual long-term returns for bonds. In
Bogle’s words, this worked out to “around 3 percent for a balanced portfolio” of 50
percent stocks and 50 percent bonds.
It goes without saying—but needs to be said anyway—that all of these crystal
balls are no better than yours or mine. And while I’m not making any predictions,
I do feel it is important to take a step back and maintain realistic longer-term
expectations, even in a time of such widespread market optimism.
David Novak, CFP® is a Certified Financial Planner™ at Novak & Powell Financial Services in Pinellas County. Please note: he is not an attorney and this article should not be construed as one offering legal advice. For information about investment decisions and financial planning, email him at firstname.lastname@example.org.