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By Christine Benz | 10-18-2012 09:00 AM

Ferri's 10-Year Market Forecast

Portfolio Solutions' Rick Ferri expects stocks to return 7% and bonds to yield 2% during the next decade, and he also offers tips on how investors should handle their fixed-income positions.

Christine Benz: Hi, I'm Christine Benz for Morningstar. I recently traveled to the annual Bogleheads event where I had the opportunity to sit down with financial advisor and author Rick Ferri.

Rick, thank you so much for being here.

Richard Ferri: Thank you.

Benz: Let's start out by discussing your forecast for the stock and bond markets, over the next decade. You recently published some forecasts on the website, let's just run through them and talk about how you arrive at them--7% equity return--but how do you get there?

Ferri: Well, the equity return is a formula based on gross domestic product growth, and let's assume we have 2.5% of GDP growth. Let's assume that we have 2.5% of dividends, but the dividend is derived by not only cash dividend, but stock buyback that gets us to 5%, and then the other 2% is inflation. And that gets us to a 7% return, and that's where [we get] the equity return of 7%.

Now, if you get a speculative bump in the market where the P/Es go from roughly 14.5 where they are right now up to 15.5, then we will see more than 7%, but I'm not putting that into the formula right now. I think that will happen by the way, but I am not putting it into the formula.

Benz: You are less sanguine about cash and bonds, expecting a 1% return on cash, about what people are earning right now, if they are lucky, and 2% for fixed income. And that's simply looking at where current yields are I imagine?

Ferri: That's correct. The cash component, the 1%, if we get that far, just looking at over the next 10 years and looking at a rather slow economy that's growing at a 2% GDP growth rate or 2.5% in that area--that's what the Fed is looking at--and thinking what would Treasury bill yields be and cash-equivalent yields be in that environment, it's about 1%.

Then I looked at the 10-year Treasury bond yield and other bonds, mostly the 10-year Treasury, which is around 1.7% today. And pretty much whatever the Treasury yield is today, the total return of Treasuries over a 10-year period is within a very close range of what Treasuries are today. So, that gives you 2%. Plus if you think about it, it works out where equities generally return as a premium about 5% over Treasuries, and so you get to 7% on equities. So, in all the numbers work out.

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