Portfolio Expectations

It's reasonable to wonder:

First, a little history. 

Since 1926, the "real return" (adjusted for inflation) for domestic stocks was about 7%/year (including dividends), and for domestic bonds about 3%/year. If history repeats, combining these in a diversified portfolio of 60% stocks and 40% bonds over the long-term would provide an annual real return of nearly:

    (60 * 0.07) + (40 * 0.03) = 5.4%

I say "nearly" because of investment expenses.


Reward/Risk chart

The table below shows what to expect from a very simple, diversified portfolio over an extended period for five different stock/bond percentages (asset allocations). More importantly, it provides a measure of what risk to expect from different asset allocations. Some comments on the chart:

To choose an asset allocation that fits your risk tolerance: Move through the columns from left to right and choose the Stock/Bond % with the highest stock percentage where you believe you have the courage to stay fully invested through the worst 1 and 3-year stretches AND the courage to rebalance after a stock downturn. When you reach a column where you might lose confidence and start selling, return to the previous column. That's a good asset allocation for you. (You can find one-year data for an even wider range of stock/bond percentages going back to 1926 at this Vanguard web page: Vanguard Portfolio Allocation Models.)

If I only convince you to read one personal finance book, this is it: The Smartest Portfolio You'll Ever Own. It is easy to read, extremely informative, and very practical. And it includes wise teaching and additional data about evidence-based, low-fee investing.

Don't be surprised that Solin's actual returns vary from the calculated returns in Row 2 (above chart). We need to start with some portfolio return models that we can use for planning purposes and accept the fact that actual returns will vary. I use the Row 2 numbers for long-term planning purposes, though I csontinually modify my short-term expectations as a function of the current economy. The chart above is the best approach I know for managing long-term returns and risks. 

Beware... 

Don't believe all the marketing hype that encourages investors to time the markets, or its segments. By this, I mean, ignore advice such as "It's time to buy (or sell) Apple." Or "It's the time in the business cycle to buy (or sell) commodities." And beware of money managers who promise to time the markets for you. After fees, expenses, and the higher taxes which are built into such arrangements, money managers won't do any better than the results described in this web page - in fact, the evidence says they'll do worse. (Read Solin, Bernstein, or a host of others). 

For more about the mix of stocks and bonds in a portfolio and how they relate to returns and risk, click on Asset Allocation and the Efficient Frontier.

After you read Daniel Solin's book, take a look at William Bernstein's 4-volume e-book series: Investing for Adults. It's a more challenging read, but it is well worth the effort! Here are the four titles:

For more personal finance authors that I recommend, click on Resources/Links.

Finally: don't be greedy. A 5%/year real return (inflation-adjusted) results in doubling your real buying power in 14.4 years. (Wonder where this comes from? See Rule of 72 in the Financial Rules of Thumb).

All the best, Tim