Will The Market Really Pay You Double Digits?
Why history may not repeat--and how to cope
(MONEY Magazine) – Your twenties and thirties are certainly the time to dream big. But dreaming big shouldn't mean living in a dream world or, for that matter, living in the past--especially when it comes to financial matters.
That's because your path to a fat nest egg may not parallel that of your parents and grandparents. Those generations enjoyed great stock returns (10.4% a year on average since 1926, according to Ibbotson Associates). And since 1950, the S&P 500 has recorded double-digit gains in 30 out of 55 years.
But your world is shaping up differently. And those differences will have a bearing on what you should expect--and what you need to do to achieve your goals.
Your parents' economy Those high stock market returns were due in large part to the economic good times enjoyed by Mom, Dad and their folks. The post-World War II boom created a large middle class and a lot of new consumers (a.k.a. baby boomers) eager to spend money. More cars and homes were sold, and new industries sprang up.
Of course, not everything was a breeze. There were periods of inflation, stagnation and high unemployment, and some tough bear markets, most recently the dotcom flameout. But on balance, our parents and grandparents had a good shot at keeping a job for decades, enjoying a middle-class lifestyle and retiring with that now dying creature, the company pension.
Your economy Going forward, the economic picture is changing, and so are expectations for the market. Ibbotson estimates that stocks will return between 8% and 9% annually over the next 20 years. Others are even less optimistic.
To understand why, consider where you're starting from today and how tough it'll be for things to get better. Stock prices go up because companies earn more profits or because investors are willing to pay more for those profits, which is reflected in the price-to-earnings ratio. In the past 20 years, both factors have been working in investors' favor. Corporate America's profits have grown and, because inflation and economic volatility have been improving dramatically, people have been willing to pay a higher price for each dollar of earnings.
But today inflation is already mild, interest rates are coming off historic lows and the economy is stable. So investors may not want to pay more for earnings than they do now. So unless profit growth really surges, there may not be much room for the kinds of improvements that helped our parents.
What should we do? Despite these stiffer odds, you can still ensure your financial success. First thing to do: Be realistic--even conservative--about how your investments will do. Certified financial planner Steven Kaye estimates that a portfolio of 70% stocks and 30% bonds will generate about 7% a year. Taxes and expenses could cut that return even more, so save in tax-sheltered accounts and look for low-cost funds.
Then take advantage of your best asset: youth. As the graphic at left shows, starting to save early can more than make up for earning lower investment returns. And never miss out on your employer's match of your 401(k) contribution.
Also keep in mind that while you may not have the same opportunities as your parents, you'll have some. New industries spring up in every generation, presenting investment and career opportunities. And there's one reality you're likely to share with your parents: No one has gone broke betting on the long-term viability of the free-enterprise system.