Investment Return Expectations

Investment Return Expectations

Having reasonable assumptions for investment returns is critically important for many reasons. These assumptions will impact the success of your retirement plan, portfolio decisions, and peace of mind to name a few.

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. Being undisciplined is akin to being unsuccessful in investing over time.

10-Year Forecasts

Blackrock and Vanguard are two of the largest global investment companies. Forecasts from them for 10-year broad asset class returns as of March 2021 and December 2022 are provided in the table. Returns are reflected in an annualized percentage and do not include any investment fees. (See links at the end of this article to sources and additional disclosures. These are just forecasts; no guarantees of course.)

10-Yr Forecast U.S. Stocks Foreign Stocks U.S. Real Estate U.S. Bond
Blackrock 03/21 6.6 8.3 6.3 1.8
Vanguard 03/21 3.4 6.5 3.4 1.9
Blackrock 12/22 7.9 10.3 1.3 4.2
Vanguard 12/22 5.7 8.4 5.9 4.6
Cumulative Index Returns 04/21 – 12/22* -4.5 -8.0 -1.9 -11.4

Upon first glance, how do these numbers strike you? Higher or lower than you’d expect coming off a rough 2022 for both stocks and bonds?

What about the comparisons between the two? Notice how bond forecasts are very similar but more dispersion exists for other riskier asset classes? And who is right – Vanguard or the more bullish Blackrock?

Building Blocks

Returns for both bonds and equities can be decomposed into various components that contribute to the total return of each asset class. Recall the total return is income return (yield) plus or minus price return (growth).

For bonds, forecasts prove to be more straightforward. As of this writing, the yield for a US ten-year note is about 4%. Starting yields are highly predictive of prospective bond returns, generally explaining more than 90% of the return. Thus, a greater congruence of bond forecasts in the table and return expectations largely in line with starting yields.

Stock (equity) asset class returns are much more difficult to forecast. Where starting yields are highly predictive of bond returns, starting prices (valuation) of equities historically have been shown to explain about 50-70% of the return variation over ten-year periods.

There are various ways to forecast equity returns and no method is perfect. One common and reasonably effective method is decomposing equity returns into three key components: dividend yield, growth, and change in valuation. These building blocks can be estimated individually and then added together to formulate total expected returns.

The dividend yield is the income return from equities. It is easily determined, varies little, and is about 1.7% for large U.S. stocks today.

Growth and valuation are two components that have significant variability through time and also vary in the forecasts of Blackrock and Vanguard. Valuation is the most speculative component. If you can predict how pessimistic or optimistic investors will be in the future, you can precisely home in on this component. Alas, this mind-reading is impossible.

Yet, from various measurements – price to sales, price to earnings, price to cash flow, etc. – we can gauge current valuation. We can then compare this to historical averages — both relative to the same asset class (large U.S. stocks vs. large U.S. stocks) and across asset classes (large U.S. stocks vs. large Foreign stocks).

Performing these comparisons, we can see that despite the broad U.S. market declining by roughly 20% in 2022, U.S. stocks still do not appear to be in bargain territory relative to their historical average valuations. A similar conclusion is reached with cross-asset comparisons of the U.S. to foreign stocks. In fact, both Blackrock and Vanguard assume that U.S. valuations continue to reserve course over the next several years and subtract 1-2% yearly from total returns.

A similar decade of negative valuation change occurred in the 2000s for US stocks following the Technology Bubble in the 1990s. This largely contributed to the S&P 500 losing money for an entire decade from 2000-2009.

Forecasting growth is also quite difficult, involves more assumptions, and has significant variability through time. In short, here Blackrock is more optimistic than Vanguard, but both believe the US will grow faster than foreign developed markets, which is the historical norm.

What Should You Do?

First and always be rational and disciplined. “Diversification is your buddy,” as the esteemed Nobel laureate Dr. Merton Miller is famous for simply saying. Yet, you may want to favor certain assets or strategies relative to expectations while maintaining a high level of diversification.

Higher growth stocks remain more expensive than lower-growth, value stocks despite value’s resurgence since COVID vaccines were announced in late 2021. Vanguard expects that favoring value stocks – both domestically and abroad – is likely to help bolster returns over the coming years.

Additionally, both forecasts favor foreign stocks over the US, so owning more of them may make sense. It’s not that expectations are for Europe or Japan to grow markedly faster than the US. Rather, the starting prices of these markets is much more favorable. And while the U.S. dollar’s strength has been a headwind for foreign stocks over the past years, more recently that has reversed and may be a continuing tailwind.

While the above comprises the simplified output of complex work that goes into providing these estimates, they are just that. The world is an uncertain place. (The above also does not venture into alternative asset class considerations or sub-asset classes within the broad categories that may enhance risk/return attributes of a portfolio.)

Most important is to update your financial, investment, and tax planning on a regular basis. These need to be well aligned to make the most of what you have and put probabilities in your favor.


Kevin Kroskey, CFP®, MBA | March 2023

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*Investment indices used are Russell 3000 (U.S. Stocks), MSCI EAFE (Foreign Stocks), Dow Jones US Select Real Estate (US Real Estate), Bloomberg US Aggregate Bond (US Bond)

Vanguard 2023 report available here.

Blackrock Capital Market Assumptions site (updated quarterly).