INVESTING WITH CLARITY™ BLOG
The New Normal
May 10, 2016 10:22:11 AM
According to Investing Daily, a new phrase that has been floating around the investment world is the term, “The New Normal.”
It’s said the phrase was initially used by PIMCO Analysis, Mohamed El-Erian in 2009 to describe the economic landscape consisting of stagflation, high unemployment, and slow growth for the next 3 to 5 years.
In a public letter that attracted global attention, El-Erian used the phrase “The New Normal” as a headline stating among other things, they expected a world of muted growth. As I thought about this “New Normal”, one of the things that came to mind was the idea that investors and their investment expectations were also entering a “New Normal”.
Historically, financial advisors and investors have used “historical average” returns in their financial planning and baseline for investment expectations. However, as we have entered a new world of different monetary and government policy, it is extremely important for investors to be adjusting their expectations as it pertains to expected rate of return on their investment portfolios.
To give you some perspective; when you think historically, and depending on the investment timeframe, many charts and marketing materials have shown the S&P 500 having historical returns averaging between 9% and 10% and U.S. Government bond returns in the 6% range. The important thing investors must consider regarding those returns is that those averages take into consideration money market and government bond interest rates at much higher levels than in the past.
For example, if you consider the money market rates at an average of 4% (which should be close to historical performance based on the numbers today’s investors have seen), the S&P 500 did an average of more like 10%, giving you an estimated difference of 6%. Now take into consideration that money market rates sit around .50%. Using the same delta, you could argue that if the S&P 500 averaged 6.5%, that could be considered equal to the performance of the 10% return and 4% money market rates. Of course, different investment objectives have different “historical” performance relative to the interest rate/investment return spread.
Investors must consider reducing their expected average returns on a yearly basis for their portfolios based on the idea that interest rates and return on invested capital at those rates are now much lower, and may remain low for an extended period of time.
From our perspective, we believe long-term average rates of returns on portfolios will be muted because of this “New Normal” of lower interest rates and monetary policy. Of course, my hope is that I am wrong and average portfolio returns begin to move to higher levels in the near future. However, when it comes to financial planning and attempting to accomplish your retirement or other financial planning goals, it is always better to be more conservative and exceed your expectations and goals, than to be short of those goals.
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