Traditionally, a diversified, or balanced, portfolio is invested in stocks for growth and bonds for preservation of principal. This somewhat simple strategy has helped balance risk and reward investors over the long term, but new currents are flowing in the world financial markets.
A report by McKinsey Global Institute, “Diminishing returns: Why investors may need to lower their expectations,” concludes that “The forces that have driven exceptional investment returns over the past 30 years are weakening, and even reversing. It may be time for investors to lower their expectations.”
The report estimates that average annual returns could potentially decline to anywhere from approximately 4% to 6.5% for stocks and 0% to 2% for bonds. The McKinsey study was produced before the rally in stocks that began late last year and continued into early 2017, but it is still very much worth considering for its longer-term perspective.
From a financial planning perspective, this viewpoint should encourage investors and retirement savers to do two things: First, make sure the assumptions that you are using for investment returns are realistic and conservative. Second, look to include asset classes other than stocks and bonds into your financial portfolio.
You should always plan for the worst and hope for the best. My team typically uses a hypothetical rate of return of no more than 4% to 5% for our clients’ financial plans.
If your investments outpace your projected returns, you will be in the comfortable position of being over-funded for retirement—a good problem to have.