Right now, it is no surprise that concern over stock market returns is rising to the surface. When one is planning for retirement or some other event down the road that requires some estimate of returns, some sort of ballpark figure is desirable. However, there is no way to truly predict stock market returns — or any other returns for that matter. But you can estimate. The Oblivious Investor offers this insight on stock market returns:
The three primary determinants of market return are:
- Dividend yield
- Earnings growth, and
- Shifts in market P/E ratios (caused by changes in the demand for stocks).
Historically, over periods of 30 years or more, the first two factors (the more predictable ones) have made up the bulk of the return, while the third factor (the unpredictable one) has performed a much smaller role–generally either increasing or decreasing the annual return by 1% or so.
At the moment, applying this formula indicates that we can expect a 30-year annualized return between 7.5% and 9.5%.
I tend to plan for a more conservative yield. I expect that my average return on stocks from now until I retire (and beyond) will be 7%, my bonds will be 4% and my cash will be 2%. In the time before the global financial crisis, all those investments were offering higher returns than that. At any rate, planning on the conservative side, I set aside money in amounts that will help me reach goals. And if the annualized return ends up greater, so much the better.