Stock markets are putting on a fireworks show. But investors shouldn't allow themselves to be dazzled by the spectacle.
The danger lies in assuming that today's blazing results will continue indefinitely.
Thanks in large part to stocks' recent record-setting performance, a wide gap is opening up between what professionals consider reasonable expectations and what ordinary investors appear to be counting on.
Consider a survey of 22,000 people in 30 countries by Schroders PLC, the money management firm. The poll, published this past week, found that Main Street investors expected to make an average annual return of 10.2 per cent over the next five years.
If people were to achieve those returns, it would be remarkable. Over the past 30 years, the MSCI world index returned only 7.2 per cent annually.
According to some observers, even the historically average returns may be out of reach for today's investors. The current bull market has already lasted an unusually long time and valuations are stretched by most traditional standards.
How bad could it get? GMO LLC, a widely followed money management firm in Boston, predicts that U.S. stocks will lose 4.1 per cent a year of their value in after-inflation terms between now and 2024. It also forecasts negative real returns for international stocks and for most bonds.
As bleak as GMO's forecasts sound, they're in line with what some other quantitative researchers are predicting. Research Affiliates LLC of Newport Beach, Calif., also sees piddling returns over the next few years.
It predicts U.S. stocks will generate near zero profits for shareholders in the coming decade. Even in cases where Research Affiliates is relatively optimistic, as with European, Australasian and Far East stocks (the EAFE index), it sees likely real returns of only 4.8 per cent a year over the 10 years to come.
To be sure, the forecasts could be mistaken. But even if they're only approximately right, there's a massive gap between what amateurs are basing their hopes on and what pros think is rational.
Anyone who plans for retirement based on achieving a 10.2-per-cent annual return will fall far short of his or her goals if returns prove to be as lacklustre as the pros expect.
To some degree, this message appears to be getting through in Canada. Expectations here are more muted than in most countries, with Canadian investors expecting an average annual return of only 8.6 per cent, according to the Schroders survey.
Still, that result is far higher than many analysts think is likely. Every year, the Financial Planning Standards Council and the Institut québécois de planification financière, two of Canada's leading financial advice organizations, issue guidelines for what they consider reasonable long-term assumptions for portfolio returns.
The most recent guidelines indicate that a moderately risky balanced portfolio of stocks and bonds is likely to generate a return of 3.9 per cent after fees.
Most of us should at least consider the possibility that the pros are right and adjust our planning accordingly. If so, four strategies could make sense.
One is to save more to compensate for the lower returns we'll be getting in future. This is no doubt the most robust strategy, but it hinges on having the necessary financial flexibility to put away more money.
Another strategy is to take more risk in pursuit of higher returns. The only problem here is that risk is, well, risky. Unless you can handle the volatility, you should think again.
A third strategy is to consider a more frugal retirement. If your portfolio doesn't produce quite the results you hope, it helps to have a backup plan.
The final and most universally applicable strategy is to keep a close eye on your investing costs. In a low-return world, it pays to find ways to ensure more of the meagre profits go into your pocket.
ETFs and low-fee mutual funds are the way to go for most investors. If you're still spending two percentage points or more a year for financial advice, it may be time to think again.