What Is a Good Expectation of Future Stock Returns?

December 26th, 2011 by Potato

In my rent vs. buy analysis, one of the factors that has a particularly large impact on the outcome is investment returns. I looked at a range of nominal returns of course, but the one I chose as my “most realistic” scenario and highlighted as the default value for the calculator was 7%/year. It could be 5 or 6 percent, or maybe even 8 or more, but for a mostly equity, low fee investor like myself with a time horizon of several decades, I figured that was pretty reasonable.

Now, that little rent vs. buy calculator (though it may take the form of a spreadsheet, at its heart it’s just like the other web-based calculators around, except you can see the formulas, and tinker a little more) has got a few people talking. Some are bashing the very notion of attempting the analysis. Others are raising very salient points, and one that keeps coming up in multiple forums is what an appropriate expectation of future investment returns should be. A surprisingly large number are saying that 7% is too high, and so far none have stepped up to say no, it may be too low and that 8 or 9% should be used instead.

So, did I aim too high? Is that not a realistic expectation? Yes, the world may be facing problems now, but it has faced problems before, and two or three decades is a long time to right the ship. But if I’m making a huge mistake by somehow vastly over-estimating market returns, that’s something I need to know. Tell me what you think is reasonable, and why.

What is your expectation of an appropriate long-term equity return?

Some data to have before voting: according to the Libra total returns spreadsheet, both Canadian and US markets have returned about 10% per year nominal CAGR over 40 years in Canadian dollar terms (vs. Canadian inflation of 4.5%). The 20-year returns up to 2010 — so including the tech wreck, 9/11, the 2008 market meltdown, and appreciation in the CAD — are about 8% from both Canadian and US markets, vs inflation at 2%. CC links to a few other reports, like a recent one in the WSJ that suggests 6.5%. Or another that says that moderate returns are in our future: 3-3.5% above government bonds. Depending on which bond is meant by that paper, that could imply stock returns of 4-6%.

Let me know in the comments, and/or visit the quick online survey.

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