Are Lower Investment Returns on the Horizon?

You don’t need to be a statistician to want to know the odds. In fact, it’s downright prudent for investors to understand what their stocks, bonds and cash investments are likely to return in the coming decade. Expect too much and you could miss your goals. Expect too little and you might needlessly sacrifice in the present—or, worse, take unnecessary risks in search of bigger rewards.

So, how do you know what to expect from your investments—and can past performance help you anticipate the future?

“Returns over the next 10 years are likely to be significantly lower than those we’ve enjoyed in the recent past across asset classes,” says Jim Peterson, chief investment officer of Charles Schwab Investment Advisory (CSIA). “Investors should take that into account when making their financial plans.”

At the start of every year, Jim and his team assemble a forecast of returns for major asset classes over the next decade, based on economic and interest-rate outlooks and current bond and stock valuations. Their most recent report walks investors through the reasons to be cautious.1

Specifically, U.S. large-cap stocks are expected to return an average of 6.7% annually from 2017 through 2026, counting dividends and share-price appreciation, while investment-grade bonds are expected to return just 3.1%.

Those forecasts are down dramatically from what investors earned in the past, says Veerapan Perianan, a senior quantitative analyst at CSIA. In fact, the average annual return on U.S. large-cap stocks is expected to be one-third lower than in the previous three decades, and investment-grade bonds are expected to return less than half of what they did in the past.

Cash investments are expected to provide especially paltry rewards—just 1.9% on an annualized basis over the next 10 years (in line with inflation), versus 5% annually for the period going back to 1970. This is probably no surprise to investors, who have seen money-market accounts and short-term deposits pay vanishingly low rates since the Great Recession.

Meanwhile, U.S. small-cap stocks are expected to earn an average annual return of 7.5% in the coming decade, according to Schwab’s forecast, and international large-cap stocks are expected to earn 6.9%. While the projected returns on U.S. small-cap stocks are very much in line with the decline in U.S. large-cap equities, the drop for international stocks is far less. That’s partly because their valuations haven’t risen to the same degree, Jim says, and so have more room for gains. Their returns are now expected to be slightly higher than those of U.S. large-cap shares in the coming decade—a departure from historical norms (See “Not-so-great expectations,” below). 

Not-so-great expectations

Returns during the next decade are expected to be significantly lower across all asset classes.

A comparison of annualized returns for major asset classes, for 1970-2016, and forecast returns for 2017-2027

Source: Schwab Center for Financial Research, with data from Morningstar. Benchmark indexes for asset classes are: the S&P 500® (U.S. large-cap stocks), the Russell 2000® (U.S. small-cap stocks), the MSCI EAFE® (international large-cap stocks), the Bloomberg Barclays U.S. Aggregate (U.S. investment-grade bonds) and the Citigroup 3-Month Treasury (cash investments). Past performance is no guarantee of future results.

What’s responsible for these diminished expectations? Jim and Veerapan cite four broad trends:

1. Sluggish economic growth. The U.S. economy grew 2.6% in 2015 and just 1.6% in 2016—and, despite the recent uptick in consumer confidence, economists see that somewhat sluggish rate of growth persisting. For example, Veerapan’s forecast is based on an annual rate of growth in gross domestic product (GDP)—the total dollar value of all the goods and services produced within a country’s borders—of 2% to 2.5% in the coming decade, compared with an average annual rate of 3.1% from just after World War II through last year.

How does that square with President Trump and Treasury Secretary Steven Mnuchin’s assertion that the U.S. can reach an annual rate of GDP growth closer to 3% to 4% with the help of tax reform and reduced banking regulations? Veerapan suggests a wait-and-see approach. If the recovery picks up steam and begins to show signs of persisting, a change in investment expectations might be justified. In the meantime, “we try not to react to near-term noise,” he says. “We’re looking at the long run here.”

2. Anemic interest rates. In the face of subpar growth in recent years, central bankers around the globe have kept benchmark rates at or near zero—and even experimented with negative interest rates—in an attempt to stimulate their economies. Even though the Federal Reserve has begun to reverse this stance, historically low rates will likely linger, justifying modest expectations for bond yields in the coming decade.

3. Lower inflation. Inflation may have averaged about 4% annually since 1970, but it has been much lower in recent years, and Veerapan anticipates annual price gains closer to 2% for the foreseeable future. “Low inflation is very much a contributing factor to diminished expected returns for both stocks and bonds,” he says. For stocks, which are forward-looking, returns tend to be depressed when low inflation suggests slow growth, while bond investors require less yield to counteract inflation’s effects.

4. High stock valuations. The final factor shaping CSIA’s forecast is that U.S. stocks have rallied with few interruptions since 2009, so “prices are marginally on the high side,” Jim says. Ironically, this encourages investors to pile into the market precisely when they should be most cautious. “The general behavioral trend is for investors to jump in after they’ve seen markets rise—at which point they’re probably too late,” Jim says. “Stocks may continue to climb for a while, but on average they are likely to record weaker long-term gains.”

Adjusting your expectations

The best plan of action is to prioritize your long-term goals over short-term performance, rather than attempt to anticipate the market’s inevitable ups and downs. And of course the expectation of slimmer gains in the coming decade makes it more important than ever to pay attention to fees and taxes, Jim says, which can needlessly eat away at returns in the best of times.

Perhaps the most central point, however, is this: By being realistic about expected returns, you’re more likely to develop an investment strategy that gets you closer to your objectives—even when that means tempering the optimism that comes from the second-longest bull run in American history.

1Veerapan Perianan, “Why Market Returns May Be Lower in the Future,”, 03/13/2017.

Next Steps

    • Given Schwab’s long-term investment return expectations, it’s more important than ever to focus on your goals and develop a plan to achieve them.
    • Get help creating a financial plan and a diversified portfolio with Schwab Intelligent AdvisoryTM or talk to a Financial Consultant.