Predictions: Compounded expected returns: 7.5% for U.S. equities, 7.2% for non-US stocks, 5.6% for bonds, and 6.5% for real estate.
James Picerno interviews Armand Yambao, who heads up financial modeling at EnnisKnupp. EnnisKnupp & Associates (EnnisKnupp.com), a Chicago institutional-investment consultancy that oversees $700-billion-plus in assets for the likes of pension funds and foundations. The 25-year-old firm is a respected force in the business of advising big money, and so it has learned much about making forecasts that are prudent yet practical for clients.
Link: Archive of Wealth Manager stories by James Picerno
EnnisKnupp’s latest semi-annual outlook, published midway in 2006, has a forecast for compounded expected return for U.S. equities at 7.5 percent a year. How does that compare with history? If you just look at historical equity returns, you’ll come up with something like a 10 percent to 11 percent annual return, and so our 7.5 percent forecast for U.S. equities is less than what backwardlooking expectations suggest.
The market’s implied outlook for inflation for the next 10 to 30 years was recently around 2.5 percent based on inflation-indexed Treasuries. Another data point comes from the Blue Chip Economic Indicators newsletter, which also had a forecast of 2.5 percent inflation.
We’re expecting a 5.6 percent compounded annual return for bonds over time.
For non-U.S. stocks, our long-term expectation is a compounded annual return of about 7.2 percent, or a bit lower than the 7.5 percent for U.S. equities. The reason for the slightly lower performance forecast is higher volatility.
For a generic real estate investment, the outlook is in the range of 6.5 percent on a long-term basis. Our long-term return expectation for real estate is somewhere between U.S. bonds and U.S. equities, and that’s how we come up with a 6.5 percent compounded return that’s between those two asset classes.
Historical returns aren’t a very good predictor of future returns. If you did a back test and relied only on history, you’d do a poor job. Let’s say that equity performance skyrockets in 2007.
Q: What’s the bottom line?
A: Investors shouldn’t blindly rely on equities to satisfy investment goals. We’re not saying avoid equities; it’s more about understanding the risks.