The Smart Take:
Having reasonable assumptions for investment returns is critically important for many reasons. These assumptions will impact your retirement plan, investment allocation, and your peace of mind.
Why peace of mind? Well, if you are expecting something unreasonable, no doubt you’re likely to be dissatisfied and more likely to be undisciplined.
Hear Kevin review 10-year return forecasts from leading money managers Blackrock and Research Affiliates. What are domestic and foreign stocks likely to do? How about bonds and real estate?
Tune in to find out and become a more informed investor.
Reminder: Investment returns are not guaranteed. There are costs to invest. Expectations discussed are just estimates and are probability-based (range-based) and are from Blackrock, Research Affiliates, and Vanguard per data available on their websites.
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Kevin Kroskey – About – Contact
Intro: Welcome to Retire Smarter with Kevin Kroskey. Find answers to your toughest questions and get educated about the financial world. It’s time to Retire Smarter.
Walter Storholt: Well, hey, there, and welcome to another edition of Retire Smarter. Walter Storholt here with you today alongside Kevin Kroskey, president and wealth advisor at True Wealth Design, serving you all throughout northeast Ohio and southwest Florida and an office as well in the greater Pittsburgh area.
Walter Storholt: You can find us online at truewealthdesign.com for past episodes to find subscription links to some of the most popular apps out there. Of course, you can always just search for it, Retire Smarter, and be sure to follow and subscribe on your favorite apps.
Walter Storholt: Kevin is joining us today as he gets ready to say goodbye to Florida and go back to Ohio. You ended up staying an extended stay in Florida with the COVID last year, Kevin. And now, coming back to Ohio, is it hard to say goodbye to the Sunshine State?
Kevin Kroskey: We feel very fortunate that we can do this and go back and forth, but we’re really looking forward to going back to Ohio. We still, I don’t know, I guess we call them both home, but it’s not like we consider one maybe any different than the other. But we’re really looking forward to getting back there.
Kevin Kroskey: My wife and my two daughters will fly, and I drive with the dogs. So that’s kind of our division of labor there. So I’ll take the girls to the airport. I will close up the house and head out early the next morning.
Kevin Kroskey: And stop in and see a few clients in the Carolinas on the way back. It’s a midpoint between up in your neck of the woods to a certain degree, I believe, Walter. And make our way back to Ohio and look forward to it.
Walter Storholt: When you travel with the dogs, do you guys crate them, or are they free roaming in the car with you?
Kevin Kroskey: So we’ve had two sets of two old English sheepdogs. So this is the first time I’ll be making a trek back with our new set that we just got last August, and we will not crate them. They’re actually really good in the car, and they love going for car rides.
Kevin Kroskey: I mistakenly turned our first two into morons in the car. I used to try to get them really pumped up to go to the park and go for a walk. And I would actually start barking at them, which in turn, they started barking. And in hindsight, I should not have done that because they were forever idiots in the car because of the idiot that’s talking right now. So the two that we have now, I mean, they’re just great, so it should be fun.
Walter Storholt: It’s interesting the unintended consequences that happen with dogs sometimes. We had one of our two dogs, she was sick for a while, and so she just wasn’t very hungry. And this was several years ago. So there was a lot of encouraging her to eat, so it was a lot of like, “Who’s hungry? Who’s hungry?” Trying to get her really excited about eating and make it a very positive experience. But by proxy would also get the second dog, who had no trouble eating at all. The same thing with you in the car got him really pumped up for eating all the time.
Walter Storholt: Now that life’s back to normal, and she’s back to eating relatively normal, it doesn’t matter because he’s been trained to when it’s food time to go absolutely nuts. So he’s literally bouncing off the walls now because that’s how we trained him to act, I guess, by proxy when he was a little bit younger, and he saw us pumping her up to get all excited for food. He was like, “All right, cool. I’ll do it too.” It’s like you can’t even get the food to the floor now with him before he’s already knocking it out of your hand and trying to get to it.
Kevin Kroskey: Right. At least we learn from our mistakes.
Walter Storholt: We’re our own worst enemies sometimes.
Kevin Kroskey: Right?
Walter Storholt: That’s right, that’s right. Well, we’ve got a really fun show today. And I know I say that every time, but you agree with me, they’re always fun. And we’re going to pick up a little bit where we left off on the last show, Kevin. We were talking about illiquid assets, real estate, business valuations, and modeling those things into a retirement plan.
Walter Storholt: And it gives rise to sort of that long-term planning focus. What do you think about how your portfolio and your plan is going to look like ten years from now? I mean, if I’m approaching retirement, yeah, I’m very invested and interested in knowing what the market, knowing what my plan is going to be doing for me in another decade. How’s that growth going to happen? What can we predict?
Walter Storholt: So I think this is a wonderful topic to bring up, especially on this milestone episode of number 75 for you for the Retire Smarter show. I want to start diving into some of these things and look at what truly is a reasonable or an unreasonable expectation for a plan as we start to model out a little bit.
Walter Storholt: I imagine that most people, I’m just going to guess, and then I’ll let you run with this wherever you want to Kevin, I’m going to guess most people have unreasonable expectations when they first start out thinking about what their plan is and what they’re able to do in retirement, or would I be wrong on that guess?
Kevin Kroskey: I would say in my experience over the last about two decades, most people expect higher returns than probably what they should, and that’s just based on some expected return forecasts similar to what we’re talking about today. So that’s not always the case, but candidly, that’s a question that we almost always ask or should always ask when we’re getting to know somebody and considering a relationship and working together. What are their expectations? It matters a great deal.
Kevin Kroskey: If you’re expecting filet, and you get served up Spam, you’re not going to be happy. I had a call not too long ago, and they were expecting 20% per year. I said, “That’s great. If you find that, sign me up.” It’s just; it’s not realistic.
Kevin Kroskey: Certainly, you may have that happen. Everything we’re going to talk about today is thinking of probabilities. And you can have 20% returns and under that probability distribution, but that’s, on average, not what you should expect.
Kevin Kroskey: So most of our clients are, I would say, humble, hardworking, educated people. And they really don’t know what to expect. We ask them the question, and they just pick a number, and most of them are open to being educated. But if you have somebody that has unreasonable expectations, candidly, I mean, they wouldn’t be a good fit for us to work with them because it’s not going to be a good relationship for either one of us.
Kevin Kroskey: But where it matters beyond that when you’re thinking about these expectations, in terms of a retirement plan, we call our process the Retire Smarter Solution, so it’s a six-step process that we go through.
Kevin Kroskey: And the step that we touched on in the last podcast was really that step one that we call it the Retirement Visualizer, so you really just, big picture. If you think of you’re in a plane, and you’re bringing it closer to the runway, it’s not like we’re landing or anything like that and doing sort of fine detail sort of work, but we’re really just formulating the big picture. And you need to pull together all your financial assets.
Kevin Kroskey: And in the last episode, we talked about how liquid assets, your stocks, your bonds, your cash, easy to value, maybe a little bit more difficult to project, which again, is what we’re going to talk about today. And then, stuff that’s illiquid: real estate, business, collectibles, things along those lines, difficult to value and difficult to project forward.
Kevin Kroskey: But really, you have to be able to look and see what sort of asset growth that you can have in your various financial assets that you can rely on overtime to go ahead and create income that you need to support your lifestyle, whether you can afford to retire if you need to work longer, save more, whatever the case may be. You have to make some assumptions about what your assets are going to be able to do for you over time.
Kevin Kroskey: So it’s really important from a retirement planning perspective. And those expectations are also going to influence how you’re going to go ahead and combine your investments into your investment recipe or your investment allocation.
Kevin Kroskey: So very, very important if you have really high assumptions, and I would say, unreasonable assumptions, that’s probably going to be a retirement plan that is not going to work and is going to fail to a certain degree. If you have a reasonable assumed growth rate on assets for your retirement plan, maybe even a tad conservative, probably something that’s going to be more realistic and more sustainable.
Kevin Kroskey: So you have to come up with some numbers. History can be a guide, but it’s what happened in the past. We’re really concerned about what’s likely to happen in the future.
Walter Storholt: I suppose you could couch those expectations in many different ways. You could take the, “Hey, let’s go with here’s what our most ideal scenario is,” and try and paint a rosy picture for somebody that paints it in a better light than maybe the situation is, try to shoot for the middle ground, or take the, “Hey, let’s plan for the worst, and then hope for the best.”
Walter Storholt: Do you subscribe… I know you don’t subscribe to the more inaccurate, “Hey, let’s just hope that the prediction is going to be the best-case scenario, but do you find you and your team sort of skewing more toward the plan for the worst idea and overshooting on the underside? Or do you really try and hit right in the middle with the most accurate, true prediction and representation?
Kevin Kroskey: Yeah, it’s a little bit more complicated than that. The way I would answer that, Walter is you need to go ahead and have good spending data, and then we go ahead and prioritize our spending goals. So some of those are needs; you really need to meet those. As the name implies, some of them are a little bit more discretionary. We use needs, wants, and wishes.
Kevin Kroskey: So what we do, we use our basically it’s a return expectation. And then, there’s that wiggle factor that we talked about on prior episodes where statistically speaking called a standard deviation that you use to go ahead and statistically model this out, model out the uncertainty, subject the portfolio and the plan to stress tests.
Kevin Kroskey: But as you go through that, and if you find that you can meet the needs for a client’s plan to a very high regard, regardless of whether you’re dealt a bad hand or not, that gives us a lot of confidence, and should then we need to convey that to the client that, “Hey, we can’t tell you exactly what’s going to happen, but we know that your needs are going to be funded to a very high likelihood. You’re not going to have to pull back from that.”
Kevin Kroskey: And then, as you move on down the totem pole into the more discretionary categories, you may find the same thing, or in certain plans that maybe will likely work, but maybe aren’t as well funded. It doesn’t mean the plan is going to fail. I would say I would rephrase that and just mean that you’re more likely to make some changes. Maybe you’re going to have to pull back on spending, maybe you’re going to have to skip a couple of big bucket list trips or something like that, something along those lines. I would say it’s more of rather than success or failure; it’s maybe likelihood of changing if you will.
Walter Storholt: I like that. And not everything in life, Kevin, has to be boiled down to A or B. So I like that some things in life can stay a little bit more nuanced. That’s not a bad thing.
Kevin Kroskey: Yeah, things should be as simple as they can be, but not simpler. Great Uncle Albert Einstein said something to that effect. And he’s smarter than me, so I’ll just, I ditto what he says.
Walter Storholt: Very good. Well, do you rely on data when you look at, let’s get back to the ten-year return expectations, I guess, why ten years? Why is that such an important marker? Why not 15 or 20 or some other number?
Kevin Kroskey: Because it just so happens what I pulled off of some of the resources that we use. So, I mean, it’s a fair question. Let me answer it this way. If we look at the forecast for returns over the next one year, the forecasting is not going to be great. There’s going to be a lot more variability over one-year returns.
Kevin Kroskey: Even think of COVID. Who would have guessed what happened in 2020 going into the beginning of the year? Stock prices were high, and then we have a pandemic, the world shuts down, and then, the stocks come roaring back in the second and third, well, really the third and fourth quarter of the year, and I guess even the second. I mean, March was terrible and sold off really quickly.
Walter Storholt: It didn’t take long to get back, did it?
Kevin Kroskey: No, nobody would have predicted that. So if you start, say a one-year, you’re going to have a much greater wiggle factor, much more disparate outcomes for one-year returns. If you go out five years, and if you look at a five-year return, well, you got some of the noise out from the short-term, and it’s going to trade more closely to what I would say the fundamental value is if you will. What’s the price of the stock or the index? What do the earnings look like? What’s the yield? Put it all together, and what we expect is more likely to happen to a certain degree. I’ll decompose that a little bit more later. But if you go out ten years, the same sort of thing.
Kevin Kroskey: And we’ve talked about this in the past, but if you think about price, so starting price, how expensive is the market? So to say, well, if you look at it and that gauge, and there are different ways to gauge how expensive the market is, but if you look over one year, there’s really no explanatory power. If you look over five years, basically, the starting price will explain about 40 to 50% of the variability in the returns. And if you go out about ten years, it’ll get closer to about 60% or so, and maybe even a little bit higher if you go out to 15.
Kevin Kroskey: So the whole point of what I just said is nobody can predict what’s going to happen, in the short term particularly. As you do go a little bit further out in time, five years, I would say, at minimum, to have some reasonable confidence, but ten years, even better.
Kevin Kroskey: This sort of, we’re not going to go through the methodology, I’m just going to talk about the numbers, but the methodology that is gone through to arrive at the numbers that we’re going to share actually has some statistical validity to it. And if you look back at that in the past, these sorts of forecasts do fall within the range that you would expect.
Kevin Kroskey: So ten years ago, and you look at some of these forecasts similar to what we’re going to talk about today, how did the next ten years play out? Well, the returns have fallen within the range that you would expect. They may not be exact. There’s always going to be a plus or minus, so to say, but the point being is the methodology is sound in that regard.
Walter Storholt: Okay. So let’s go down that path a little bit further then and look at some of those.
Kevin Kroskey: Whenever you’re talking about return expectations in this business, again, these are probabilities that we’re talking about; just don’t take this as gospel. Basically, these are, they’re very sophisticated, and again, there’s validity to it, but don’t take it like, “Hey, this is what I’m going to get over the next… ” These are expectations.
Kevin Kroskey: Think about this in terms of probability with a range. I’m just going to simplify it and talk about more of a number if you will. But that’s just really, really important to keep in mind.
Kevin Kroskey: And the numbers that I’m going to reference here were taken from BlackRock. So BlackRock is the world’s largest asset manager. I don’t know something north of $4 trillion under their advisement. So most people have heard of BlackRock. iShares is probably what they’re most commonly known for here in the US. But their data was taken as of March 31st, so it’s pretty current. The market hasn’t moved all that much since the end of March. So fairly good there, particularly when we’re thinking about ten years.
Kevin Kroskey: And then, the second is a company called Research Affiliates that people probably have not heard of, and I’m not exactly sure how much they currently advise on, but they have a lot of different, I don’t know, it’s in the hundreds of billions of dollars that they go ahead and advise on if you will.
Kevin Kroskey: So two really good sources, I just picked two and then averaged the two. And Research Affiliates was as of the end of April. So a little bit different, off by a month between the two, but hey, that’s what I had at my fingertips, and they update them with different frequency, so there we go.
Kevin Kroskey: So what I’m going to go through is just a handful, really broad asset classes. Again, you can get more sophisticated than this, but this is certainly good to help form these expectations that we’re talking about, input into our retirement plan for reasonable projections and reasonable assumptions, and then also to help formulate what we want our investment mix to be like.
Kevin Kroskey: So if we just look at large US stocks, Walter, I got to weave you in here, buddy. I mean, what do you think? What should we expect for the next ten years for large US stocks?
Walter Storholt: Let’s go like 8% a year, so 80%.
Kevin Kroskey: All right. So you said 8% per year. So BlackRock has it at 6.6, Research Affiliates at five. Average the two together, and we’re just a little bit under six at 5.8.
Walter Storholt: I’m an optimist.
Kevin Kroskey: You’re an optimist, but I know you know this, and I’ve asked you this many times over the years, so as long as you’re paying attention, you’ll get this one right. No pressure. So what’s the return of the S&P 500 over time if you look back through history?
Walter Storholt: Isn’t it seven, eight, nine percent, somewhere in that range?
Kevin Kroskey: Oh, Walter.
Walter Storholt: Well, we haven’t talked in a little while, you know?
Kevin Kroskey: All right. All right. Well, it’s a little bit north of 10, but let’s just round it down and call it 10%. So if we’re at 10% historically, and that’s basically from.
Walter Storholt: Well, that’s why I originally said nine. I was only 1% off.
Kevin Kroskey: Walter, you originally said eight.
Walter Storholt: Did I say eight? I thought I said nine. All right, well, one or two plus or minus, the standard deviation, the wiggle factor.
Kevin Kroskey: You’re losing some street cred here with our audience, buddy. So historically, the returns have been an annualized 10%. The market almost never returns 10% per year. It just averages out that way. But Walter said eight, BlackRock says 6.6, Research Affiliates says five, put together 5.8. There are some others that I didn’t necessarily put in here, but you’ll see some that are maybe slightly more positive, not so much. A lot of them are in the six, seven percent range. Some are quite a bit more pessimistic than five, actually, in the low single digits.
Kevin Kroskey: But nonetheless, you put that together, let’s just call it an average of six, certainly a lot lower than the historical 10% that we just mentioned. So very, very different there. So if you’re expecting just history at 10, and BlackRock saying, “Well, hey, that’s two rosy,” Research Affiliates saying, “That’s really rosy, we’re thinking about half of that,” Well, you’re probably going to be disappointed if you’re going down that path and maybe making some bad investment decisions if you have those unrealistic expectations. So something important to notice there.
Kevin Kroskey: So that’s the largest companies in the US. If we go outside of the US, so international developed countries, Europe, Japan, Australia, Canada. All right, Walter, go ahead. You’re guessing, buddy, what do you got here, ten-year returns?
Walter Storholt: Ten years, oh, gosh, I have no idea. I don’t even know where to begin.
Kevin Kroskey: Greater or less than the US?
Walter Storholt: Let’s say less.
Kevin Kroskey: All right, so both of them are actually higher than the US. So you’re 0 for 2, buddy.
Walter Storholt: 0 for two, man.
Kevin Kroskey: Don’t worry, you haven’t struck out yet. We’ll get you back here in the game.
Walter Storholt: It’s all right. It’s baseball season. I can still turn this around.
Kevin Kroskey: Yeah. BlackRock has 8.3, Research Affiliates, 6.5, put them together for an average of 7.4. We’re a little bit more than one-and-a-half percent per year, more return expectation for large international stocks than domestic large stocks.
Kevin Kroskey: So part of the reason is the US has done quite well over the recent past, has gotten a lot more expensive, and just the starting prices are a lot more favorable outside of the US. So that’s pretty consistent, not only with BlackRock and Research Affiliates but with several others that I review. In fact, I don’t think any other return forecasts that I’ve reviewed on a regular basis have the US doing better than foreign stocks. So something to keep in mind for all. I know we have somewhat of an international audience. I forget the country that you mentioned we had a listener in, but-
Walter Storholt: Was it a Luxembourg or something like that maybe we had on.
Kevin Kroskey: No, I can’t recall. But anyway, most people have most of their money, and most US citizens have most of their money in US assets. So they need to think a little bit differently going forward and favor a little bit more international diversification.
Kevin Kroskey: So those are developed foreign stocks. What about the emerging economy? So here we have China, India, Brazil, even South Korea. So emerging markets. All right, Walter, let me think about how I want to phrase this question.
Walter Storholt: Yes.
Kevin Kroskey: All right, is the return expectation higher or lower for US stocks in emerging markets?
Walter Storholt: I would say higher.
Kevin Kroskey: You’re correct. All right, you’re on base, buddy.
Walter Storholt: Okay, all right.
Kevin Kroskey: I’ll give you a single there. So actually both of them have-
Walter Storholt: That’s a respectable day, yeah.
Kevin Kroskey: 7.4, so they’re both uniform there. So now here, we’re at 7.4, so again, a little bit more than a point-and-a-half more for emerging market stocks than US stocks. Everything that we’ve said so far is pretty much between like five and 8% in terms of the range of expectations for those stocks.
Kevin Kroskey: If we go into real estate, the average there is about 6% is what they’re expecting. And now, if you go into bonds, call it two-and-a-half between the two, so if you’re just looking at an aggregate bond mix, about two-and-a-half percent.
Kevin Kroskey: If you put that all of that together, so again, large US stocks about six, foreign stocks, closer to seven-and-a-half, real estate about six, aggregate bonds about two-and-a-half. And you put that together in a portfolio, maybe 60% stocks and 40% bonds, you’re going to get somewhere close to 5% or so on a return expectation basis over the next ten years. How does that strike you, Walter?
Walter Storholt: I mean, not terrible, but reasonable, I would say.
Kevin Kroskey: Yeah, one way I would think of it, so we mentioned historical return for US equities was about 10%, the historical returns for bonds, call it like five-year government bonds, is about 5% over that same time period.
Kevin Kroskey: So if you think about your excess return of stocks over bonds throughout the last 100 years or so in the US, it’s been about 5%. And if you think about the returns for stocks versus bonds here, it’s not too dissimilar. The thing that I would say is interest rates are a lot lower than what they really ever have been.
Kevin Kroskey: So, on average, we could probably still expect that, hey, we’re going to get maybe an extra, if we’re unlucky maybe 3%, but probably more likely four or five, maybe if we are lucky 6% more for owning stocks versus bonds. And that’s been pretty consistent with what we’ve seen through history. So it’s all relative, so to say.
Kevin Kroskey: Inflation was a little bit higher over the past. I know we have a little bit of a spike of that right now. But in general, it’s been a lot lower over the last couple of decades and probably is going to stay lower if we look out, say, ten years from now. At least that’s what current market expectations are.
Kevin Kroskey: So it’s not just the nominal or the total number that matters so much, but it really is the return. It’s really your net returns, your net returns after costs and after taxes, and really after inflation too, that matters and will drive the success of your retirement plan over time. So it looks like we’re still going to get compensated fairly well for owning stocks, at least to a similar degree to what we’ve got compensated in the past.
Walter Storholt: The other popular country, by the way, I looked it up, Northern Mariana Islands. They’re just north of Guam. You have actually quite the listenership there. In the past three months, it’s the third… Let’s see, yeah, third most popular country for downloading the podcast, so there we go.
Kevin Kroskey: All right, there we go.
Walter Storholt: And you do have a Luxembourg listen, just one, but you did register there.
Kevin Kroskey: We have a few clients that are from Luxembourg, so maybe they’re listening while they’re over there.
Walter Storholt: And that’s what happens, yes. If you listen while you’re in one of these other countries, if you’re traveling or something, it’ll ping as a listener there. I suppose there could also be some VPN play at work if somebody is using a VPN on their phone or something like that and using another country to access the internet. I wonder if perhaps that registers a download from one of those other countries.
Walter Storholt: Otherwise, you have quite the travelers when it comes to your clients because you’re registering a listen in lots of different… At least like one or two listens in lots of other countries, but a significantly decent amount in the Northern Mariana Islands to where I actually think you may have somebody hanging out there enjoying the show. So there you go.
Kevin Kroskey: Very cool. One of the things that are really important that I mentioned here, so again, call it between five to eight percent for various types of stock-based investments, whether it’s domestic or foreign, foreign developed or emerging, a little bit less for real estate, a lot less for bonds.
Kevin Kroskey: If you look within the equity markets, you look within the stock markets, and we’ve talked about this a lot over the last year, tech stocks had done really well going into and leading up to 2020, and then they did really well going through COVID, and they’ve done so well that they just got really expensive that it was very unlikely that they were going to continue to do well. Not that they were bad companies, it’s just that the price had gotten so high, so even though they were good companies from an investment perspective, they are very unlikely to be good investments going forward.
Kevin Kroskey: And that’s really played out over the last, call it, year or so now, particularly over the last six months as the vaccine has been developed and distributed maybe eight months or so now. But the difference between value and growth stocks in technology, definitely more prevalent within growth stocks. And value, you can just think of value as lower growth, maybe more traditional sort of investments. They tend to have a little bit more financial services, more energy, more industrials.
Kevin Kroskey: A lot of those lower growth stocks were more harmed during COVID and actually had been out of favor for many years relative to the higher growth, high fliers, the FAANG stocks, Facebook, Apple, Amazon, Netflix, and Google, can even add in Microsoft there as well.
Kevin Kroskey: But in short, that disparity or the difference between those lower growth and higher growth stocks really reached a historical peak in the US last year, and we’ve seen quite a strong rebound where these lower growth value stocks are doing really well.
Kevin Kroskey: And generally speaking, the sign shows that you want to tilt towards and own more of those value stocks than the growth stocks. And this is something that’s probably going to continue to play out for over this ten-year timeframe that we’re talking about. You never know exactly the path, but in general, a lot of these return expectations are projecting the value stocks should, on average, over the next 10 years, maybe do three, four, or five percent better than the higher growth stocks, largely, the tech stocks.
Kevin Kroskey: So three, four, five percent per year, again, if you compound that over ten years, you’re talking about quite a big dollar difference multiplied over those ten years. But with anything, you may want to favor some of the things we’re going to expect to do a little bit better, whether that is foreign stocks or value stocks, and then own a little bit less of the things that are maybe overly expensive, largely a lot of these tech darlings that had done so well coming into and through the beginning of COVID.
Kevin Kroskey: Even if the returns are maybe a little bit lower, maybe if they do come in at say like four or five percent and a little bit more at the lower end of the range for US stocks, if you do favor some of these lower growth value stocks, maybe a little bit more small stocks than large stocks, that’s another way to go ahead and get the return expectations up a little bit more than just owning like the S&P 500 broadly.
Kevin Kroskey: So we’re just talking about some broad averages here, broad expectations. Certainly, how you would actually go and use this information to construct a portfolio, it gets more complicated, as you can imagine. But nonetheless, I think that could be the saving grace. Even if we are in a low return environment, owning some of these stocks that have been out of favor, they’re likely to continue to come back as they have over the last six or eight months, and that’s likely to continue to happen for several years ahead of us.
Walter Storholt: So much happens in 10 years. It’s just amazing to try and predict where all these things are going to be. I’m curious, Kevin, and you may not have this data on hand, but I’m just curious, we have the historical returns, the 10% or slightly north of 10%. I’m never going to forget that now, Kevin. I will ingrain that into my memory. I think there was a bird outside the window that was distracting me when I answered that question earlier today, so cut me some slack.
Walter Storholt: But I think I want to lean more toward the historical when it comes to these kinds of things. Just seeing this past year and all the crazy things that can happen and how hard it is to predict. They’ve been making these predictions, I imagine, for a long time, do we have data on how well their predictions have panned out in the past? Their these assumptions that they’ve made or these prognostications have they been relatively accurate in their previous iterations?
Kevin Kroskey: Yeah, yeah, they have. In fact, I did mention that going through this. So Research Affiliates itself, I just actually reviewed a piece recently where they looked at some of their historical projections, and without getting too far into the mathematical weeds, the short answer is yes.
Kevin Kroskey: I’ll answer it maybe a little bit differently. Bonds are easy, relatively easy to predict if you just decompose where bond returns come from. And if you just think of it like a US government bond, whatever the starting yield is, it is going to explain almost all of the return going forward.
Kevin Kroskey: So 10-year US government bonds today trading around 1.6%. You hold that bond over that ten-year period. That’s what you’re going to get. If you get into more credit-sensitive bonds, corporate bonds, junk bonds, things like that, then not only do you have an interest rate exposure, but you have a credit exposure there. So it’s a little bit more complicated. But nonetheless, bonds are pretty easy to forecast, particularly the high-quality treasury bonds.
Kevin Kroskey: You get into stocks, and you can really think about maybe three variables there. The starting yield, that’s easy. You can just see, okay, what’s the yield on, say, the S&P 500? Well, today, it’s below 2%, so we know what the starting yield is there. And then, you really look at earnings growth per share.
Kevin Kroskey: So I didn’t mention this, but BlackRock thinks we’re going to grow a lot more than what Research Affiliates thinks, both here domestically, as well as outside of the US. But I mentioned per share; their companies are always issuing shares. Executives, key employees may get equity compensation. So basically, there are more shares being issued, which means that current shareholders are being diluted to a certain degree. So it’s always the earnings growth on a per-share basis.
Kevin Kroskey: And then, the third, so I got yield, I got earnings growth per share, and then really it’s a change in valuation. And the valuation changes. You can’t really predict how people are going to feel. Are they going to bid up prices? Are they willing to pay the prices that they are today, which are pretty high? Or in 10 years, or are they going to maybe not be willing to pay as high of a price, and maybe it’s going to go back closer to what it’s historically been?
Kevin Kroskey: So if prices go back to what they’ve historically been, then basically that valuation change is going to be a negative contributor to our total return. So the yield is pretty easy. Earnings growth is a little bit more difficult. There’s a lot more variability there to predict. But over long periods of time, you can do a pretty good job estimating that.
Kevin Kroskey: The valuation change is speculative. John Bogle from Vanguard had a similar sort of model that he talked about. I saw him talk about it at a couple of conferences while he was still alive over the years. And he talked about those first two that you can forecast. Certainly, the yield’s easy, earnings growth over long-term is fairly predictable, short-term, not so much. And then, the valuation change is speculative because the market’s comprised of people, and people are emotional, and you don’t know how that emotion is going to strike the market on any given day.
Kevin Kroskey: There’s been a lot of weird things going on in the market with GameStop, with Hertz, with AMC, with people bidding up certain prices of a stock and irrespective of what the fundamental value is. But inevitably, that music is going to run out, and people are going to be looking for chairs, but you just don’t know when that’s going to happen.
Walter Storholt: That’s a great analogy, actually, of the musical chairs and that same feeling of, “Uh-oh, I don’t see a chair nearby me.” I feel like you’re right. There’s going to be a lot of people that fall into that same feeling in the pit of their stomach when it comes to some of these crazy things that we’ve seen happen in the market over the last couple of months. It’s definitely been interesting to watch.
Walter Storholt: So ten-year return expectations, there’s the skinny on it all. And how do you then, Kevin, I guess, to put a bow on this, wrap all that into somebody’s financial plan? Do their emotions and their appetite for risk and for these expectations then play a role in how you then develop that plan?
Kevin Kroskey: Oh, yeah, for sure. I mean, this is part of pretty much every conversation that I have with a client. We talk about, we’ve been taking more risk now for many clients for about a year or so, and clients have certainly benefited from that with higher values in their accounts, and they’ve been very happy.
Kevin Kroskey: And the common question is, “Hey, does it make sense to still do this?” So if you just think through what we talked about today, we’re still likely to get compensated pretty well for owning stocks relative to bonds. So the conclusion for most people is, yes, at least financially speaking. We still have to talk through it qualitatively and make sure that they feel comfortable with it.
Kevin Kroskey: But we talk about it, maybe a good way to answer this too, is if you go back there are, I think, two series that we did, one on retirement income. And I talked about how it needed to be dynamic and how we need to adjust our portfolio given expectations. So we talked about expectations today. We’ve adjusted client portfolios many times over the years and to quite a degree over the last 14 months or so as stock price prices sold off.
Kevin Kroskey: So that’s always a conversation that we’re having with our clients. It is really couched within the context of financially what makes sense? What kind of return do they need for their financial plan to work? How much risk can they afford to take? We call that risk capacity. We really measure that within their financial plan. We don’t want them to have to make an adverse change to their lifestyle if a bad event happens and we’re taking too much risk and take it on the chin.
Kevin Kroskey: And then, really, it’s the risk tolerance and how much they’re comfortable with. So most people want to sleep comfortably at night, and you don’t want to get them out of that comfort zone. At every single meeting, we’re talking about this and just trying to make smart decisions. If we’re not likely to get compensated for taking more risk, then it probably doesn’t make sense to do it.
Kevin Kroskey: So it’s definitely a dynamic world that we live in. And as you get new information, the same process, but you got to feed that new information into the process, so you may have a different outcome.
Walter Storholt: That’s a great way to look at it. If you’re not going to get compensated for the extra risk, why take it? And I know that you have a great mentality when it comes to analyzing all of these things, Kevin.
Walter Storholt: And if you’ve been putting together a financial plan or a retirement plan and haven’t had this level of conversation with your advisor, it might be time to have that kind of conversation. And you can set up a 15-minute call with an experienced advisor on the True Wealth team by going to truewealthdesign.com. Just look for the “Are We Right for You” button. Again, truewealthdesign.com, or you can call 855-TWD-PLAN. That’s 855-TWD-PLAN. And we’ll put that contact info in the description or show notes section of today’s show, so it’s easy for you to find.
Walter Storholt: Kevin, thank you so much for the help and the guidance on the show today, and looking forward to more episodes with you soon.
Kevin Kroskey: All right, Walter, I look forward to it. I’ll record next time from Ohio.
Walter Storholt: There you go. 75 down, 25 more to a number 100, my friend. So I guess we’ll get there in just about a year at our current pace. That’ll be a fun day to celebrate. But congrats on your mini-milestone here of episode 75. And thanks to everybody for joining us on the show today. We’ll talk to you next time right back here on Retire Smarter.
Disclaimer: Information provided is for informational purposes only and does not constitute investment, tax, or legal advice. Information is obtained from sources that are deemed to be reliable, but their accurateness and completeness cannot be guaranteed. All performance reference is historical and not an indication of future results. Benchmark indices are hypothetical and do not include any investment fees.