Vanguard’s Prediction Of Future Market Performance

In summary: Bonds will not be impressive, interest rates will remain low, stocks will return somewhere in the 5-8% range over the next decade.

I decided to start with the summary so that you don’t waste your time reading the details. But there are some more interesting tidbits which are worth talking about.

Vanguard’s CEO, Bill McNabb, wrote a few paragraphs on the annual report which Vanguard emailed me today. 70% of my investments are held in Wall Street, 5% is cash and 25% is in real estate.

Why Try To Forecast Changes?

What’s the reason that the CEO of Vanguard would want to post a prediction about upcoming market performances? I think it’s mainly because the clients demand it, but also because it helps the company relate to the Jane/Joe investor.

Does it matter if Bill is wrong? No. Does it matter if he is right? No. Remember, it’s going back to your investment policy statement, where you decided whether Wall Street offers sensible investments which you would like to be a part of, in order for you to grow your wealth.

By Wall Street, I am referring to stocks, bonds, REITs and other similar investment products. These could be individual stocks or ETF’s or index funds.

There are those who are profiting beautifully by spending a couple hours every day trading individual stocks. And there are those who are in the long-term holding strategy, waiting for the time they get close to retirement to convert their mostly stock-leaning portfolio to bonds or cash equivalents.

Understand The CEO’s Limitations

Could Bill write: “The economy is fucked, we probably going to devalue the dollar in the next decade and expect a collapse of our banking system which will take a decade to recover from.”? No, he couldn’t do that because everyone would pull their money out of the business which is Vanguard. They exist to make money, they will write and do what it takes in order to make money.

I have nothing against Vanguard, I hold my investments inside VG and believe in their business model. But I do believe that they will say and write whatever will keep me invested with them, or at the very least, within Wall Street.

Could the CEO write: “We expect that the volatility of stocks and the poor returns of bonds over the next decade will make them a terrible investment option and that real estate or CD’s will probably fare much better.”?

On Global Economic Outlook

Bill writes some very interesting words on how digital technology and expansion of free trade among nations is equalizing the growth difference we see locally versus globally.

Economic growth, interest rates, and inflation are predicted by the VG group to remain low, in the near future. This is probably the pithiest of statements Bill made in his little opinion piece.

He goes on to say that in the long-term, this will likely pick up. I like the little happiness sandwich piece he delivered here. But there isn’t much predicting going on, saying that the economy will stay the same for a while and then change – I think my dead cat could predict that.

Global equities are predicted by VG to return somewhere in the 5-8% range. Interestingly, this is higher than what others are predicting but it depends on how much of your portfolio leans towards international, small-cap, value, US markets, etc..

More importantly, Bill with the help of Joe Davis, believe that a balanced portfolio with a 60% stock and 40% bonds will likely return far more anemic returns than historical returns – somewhere in the 3-5% range.

A quick note, these are nominal returns, similar to a gross paycheck which doesn’t have taxes deducted from it. A nominal return doesn’t factor in taxes, fees, nor inflation.

Take 5% of returns.
Subtract 15% taxes = 4.25%
Subtract annual inflation of 2% = 2.25%
Subtract annual fees of a mutual fund = 2.15%

That 5% nominal rate of return becomes a real 2.15%.

On Inflation And Interest Rates

Inflation is predicted by VG to spike up slightly and then steady out. They estimate it will be somewhere in the 2% range in 2017 and likely 2018.

Naturally, when inflation increases, the federal reserve would raise interest rates. I’m not sure how direct of a correlation this is historically, however, VG predicts that because inflation will be muted, so will interest rate hikes, all the way through 2018.

What This Means For Me

I am following a long-term strategy with my investments. I have worked hard since graduating residency in 2009 and have been saving diligently since 2012.

I am worried as much as the next person about how my investments will perform in the market. I fear getting wiped out and having to start over from scratch.

At the same time, I am building a sort of resilience in my personal financial life. I will continue to put extra money towards my Wall Street investments and will remain invested in the market. However, the majority of my focus now is on decreasing my dependence on income, decoupling my lifestyle from the value of local currency and investing the majority of my time and income on myself and my social network.

I am less worried about how inflation will affect me because the consumer price index is becoming less and less relevant to me and my personal rate of inflation is taking center stage.

I realize that my current net worth of somewhere in the $700k range can drop down to $400k. But I also realize that I have a long-enough time horizon that I can weather such a massive, yet expected, decline.

I believe that the markets will fluctuate drastically but predictably. I will continue to diversify my investment portfolio to include real estate, business, intellectual property, peer-to-peer investments and intangible assets.

I strongly believe that taxes will play a bigger and bigger role in depreciating the value of my assets. I am safeguarding against this by decreasing my tax burden. The best way I know how is by decreasing my income – earn less, pay less.