What Market Experts Are Saying About Future Returns

The start of a new year isn't just the season for resolutions. It's also prime time for predictions. With each website you visit and television program you see, you're apt to hear prognostications about everything from the 2016 election cycle to the Stanley Cup to the Oscar race.

You'll also hear plenty of guesses about what the stock market is likely to return in the year ahead. Many of these prognostications are made in good fun--such as our now-annual survey of Morningstar.com users' return expectations. As well they should be. Equity returns, especially, are difficult to forecast in the short run, buffeted around by unpredictable factors such as economic conditions both in the U.S. and overseas, geopolitical events, and--perhaps the most mercurial of all--investor sentiment.

Forecasting the market's long-term returns, meanwhile, is a more worthwhile exercise, and arguably a necessary one. After all, users of even the most rudimentary financial calculators are called upon to enter what they expect their portfolios to return over their holding periods, right alongside their current savings, future contributions, and time horizons.

Investors could, of course, plug in historical long-term average returns for both stocks and bonds--roughly 10% and 5%, respectively. But past is not prologue. Starting yields have historically been a good predictor of what bonds are apt to return, and intermediate-term bond yields are currently about 2.5%--less than half of the average long-term return for bonds. Meanwhile, many market watchers believe that a 10% return expectation for stocks is unrealistic, too, given that today's equity valuations aren't especially low relative to historical norms.

What's a well-meaning investor to do? I've argued that erring on the side of conservatism is a good strategy when it comes to market returns--that is, embed conservative return assumptions into your planning. The net result of using a pessimistic forecast may be that you'll have to save more, work longer, or both. But if they think rationally about it, most investors would rather risk a happy surplus than fall short.

It can also be helpful to consider what a range of well-regarded investment experts are forecasting for returns from various asset classes. With that in mind, I've compiled links to their research below. Note that there are variations in time horizons--the investment firm GMO famously uses a seven-year time horizon, for example, whereas other providers use a 10-year horizon or even longer. The experts also differ in how they present the numbers; some provide real (inflation-adjusted) return forecasts, while others provide return and inflation projections separately. Finally, various firms slice and dice the investment universe differently; some firms formulate a forecast for the U.S. market in aggregate, for example, while others consider small- and large-cap stocks separately.

John C. Bogle, Founder of Vanguard Group Highlights: 6% nominal (non-inflation-adjusted) equity returns during the next decade; 3% bond return (Fall 2015).

Bogle, the founder of Vanguard Group, shares his asset-class return forecast each year at the Bogleheads conference, and he also discussed it in this research paper in The Journal of Portfolio Management. To forecast equity-market returns over the next decade, Bogle combines dividend yield with anticipated earnings growth, then nudges that sum up or down based on likely P/E expansion or contraction. To anticipate bond returns over the next decade, Bogle uses current yields. Not surprisingly (but wisely), Bogle exhorts investors to consider the additional return drag imposed by fees, taxes, and inflation.

GMO Highlights: negative 2.1% U.S. large-cap real (inflation-adjusted) returns during the next seven years; negative 0.9% real U.S. bond returns (Nov. 30, 2015).

(login required) are legendarily pessimistic, and its latest output, dated Nov. 30, 2015, is no exception. Viewing broad-market valuations as frothy, the firm is forecasting flat or negative real returns during the next seven years for every equity category save one--emerging markets, where it is forecasting a 4.1% real return. Nor is GMO's outlook especially rosy for bonds; the firm is expecting a small annualized inflation-adjusted loss from U.S. bonds during the next seven years and an even weaker showing from hedged international bonds. The sole highlight on the fixed-income front is emerging-markets debt, where the firm is forecasting a 2.2% real return during the next seven years. (GMO is assuming an inflation rate of 2.2% during the next 15 years.) GMO's Ben Inker provided more color on some of these same ideas in this video.

Josh Peters, Morningstar Director of Equity-Income Strategy and Morningstar DividendInvestor Editor Highlights: 6-7% nominal (4-5% real) returns for the S&P 500 over the next few decades (December 2015).

Peters revisited his return expectations for both the S&P 500 and his dividend-focused portfolio in the December issue of Morningstar DividendInvestor. In recognition of the S&P's fairly low current dividend yield of 2% and his muted expectations for real dividend growth (he's assuming 2% to 3%, a step down from the real dividend-growth rate of 5% during the past 10 to 12 years), Peters believes future market returns will fall short of their long-run returns. To help offset declining dividend growth, Peters believes that focusing on above-market dividend yields will help investors gain a performance edge relative to the S&P 500. He discussed this thesis in this video segment with markets editor Jeremy Glaser.

Matt Coffina, Morningstar Equity Strategist and Morningstar StockInvestor Editor Highlights: In a Morningstar.com commentary in late December, Coffina opined that the equity market would be unlikely to return more than 6% to 8% over the long run.

In his commentary, Coffina suggested that investors embed muted return forecasts for equities into their investment plans. He points out that stock valuations are high relative to historical norms (though they've come down a bit in the past few weeks), in large part because corporate earnings--the "E" in P/E--have declined. Yet, he also believes that the market's infatuation with a narrow subset of growth stocks such as

Morningstar Investment Management Highlights: 4.5% 10-year nominal returns for U.S. stocks; 2.6% 10-year nominal returns for U.S. bonds (January 2016).

Like GMO and Research Affiliates, Morningstar Investment Management's return expectations for U.S. stocks and bonds are low, if not downright discouraging. (Note that these are nominal returns, not inflation-adjusted.) But the outlook is more optimistic for foreign equities, with return expectations in the 7% range, indicating that globally diversified investors could be well rewarded. (Morningstar Investment Management will begin publishing its return expectations for core asset classes in the next issue of Morningstar Markets Observer, due out in early 2016.)

Research Affiliates Highlights: 1.1% real returns for U.S. large caps (the S&P 500) during the next 10 years; 1.1% real returns for the Barclays U.S. Aggregate Bond Index (Dec. 31, 2015).

Research Affiliates deserves plaudits for transparency; the firm makes

easy to retrieve and understand. (Its methodology for calculating expected returns is

.) While the firm anticipates barely positive real returns for U.S. stocks in the decade ahead, it is notably sanguine about investing in foreign stocks over the next decade, predicting a 5.3% real return for the MSCI EAFE Index of developed foreign-markets stocks and a 7.9% real return from emerging-markets equities. Like GMO, the firm is also relatively positive on the prospects for emerging-markets bonds, especially those denominated in local currencies. Research Affiliates has steered

Charles Schwab Highlights: 6.3% nominal returns for U.S. large caps (the S&P 500) during the next 10 years; 3.3% nominal returns for the Aggregate Index (April 2015).

In a report from April 2015, the market experts at Charles Schwab were predicting returns during the next decade that were roughly in line with Bogle's expectations. The firm believes that small- and mid-cap U.S. equity investors will earn a slightly higher return than S&P 500 investors, whereas investors in the MSCI EAFE Index of developed-markets stocks will fare a bit worse. The firm's report notes that those return expectations are below historical norms but cites low inflation and low interest rates as the rationale. (Its long-run inflation expectation is 1.8%.)

Vanguard Highlights: Nominal equity-market returns of 6% to 8% during the next decade; 2% to 2.5% expected returns for global fixed-income markets (December 2015).

Vanguard's Capital Markets Model provides a range of probabilities for returns from various asset classes; the firm's investment experts discuss those projections, as well as the firm's overall economic outlook, in this report. For equities, the firm's model places the highest probability of nominal returns in the 4% to 8% range for the next 10 years; equity returns in the 8% to 12% range are the next-most-probable scenario. The firm's research also suggests that investors in foreign stocks that are not hedged into the dollar could outperform the U.S. market in the next decade. "Vanguard suggests that investors who currently own equity portfolios with a high degree of home bias take advantage of global diversification benefits by rebalancing toward non-U.S. exposures," the firm's market experts wrote.