Jack Bogle, Vanguard Founder Agrees – Lower Stock Market Returns Ahead

For a while now, I’ve been using lower forecasts for stock and bond market returns over the next 10 years than the long-term historical averages. I think financial planners, advisors and brokers do their clients a disservice by using the Ibbottson average returns since 1929 when stocks are currently valued well above average, profits peaked a couple years ago and have been lower for the past six quarters in a row and the tailwinds that drove the increase in stock and bond prices since 1982 have one by one largely evaporated or become less of a factor.

I think 5%-7% on stocks is a more realistic assumption over the next 10 years and 2%-4% on bonds. That’s one reason you have heard me talk to clients more about alternatives, especially real estate. If you run a 401(k) it should have you considering some alternatives, though liquid alternative funds on the whole have been disappointing in their performance.

It should also make a difference in what you assume you’ll have for retirement and should prompt you to prudently consider upping your 401(k) and other retirement contributions.

So, when I read Morningstar’s Christine Benz interview Jack Bogle, the founder of Vanguard Group, I was interested to see that he agrees with me and is actually even a little more pessimistic. I have excerpted some comments from that interview below. You can read or watch the entire interview at http://news.morningstar.com/Cover/videoCenter.aspx?id=772785


Christine Benz: Hi, I’m Christine Benz for Morningstar.com. I recently had the opportunity to sit down with Vanguard founder Jack Bogle. We discussed his return forecasts for the major asset classes. Jack, thank you so much for being here.

Jack Bogle: Always good to be here, an annual occasion, Christine.

Benz: It’s an annual privilege for me. Let’s talk about your return expectations for stocks and bonds starting with equities. I think you have a really intuitive formula for forecasting equity market returns over the next decade. Let’s talk about how you get there and where you arrive.

Bogle: Sure. It’s very simple, easy to explain. Everybody knows this, but I don’t think anybody else has ever put it down in the way I have. I’ve been using it for 25 years and it’s worked beautifully for the full period. Every once in a while a decade is off by a good bit and then it’s made up in the next decade. But it places stock returns into two categories: investment return, that’s what you’re earning on the stock. That’s your dividend yield when you buy in–a crucial number–and the earnings growth that subsequently follows. And the other is speculative return, which is change in valuation of stocks generally, easily measured by the change in the price/earnings multiple. And for example, which happened in the ’80s and again in the ’90s, the price/earnings multiples roughly doubled twice from 10 to 20, and that doubling is a 7% per year increase in valuation, and it did the same thing the ’90s, that’s a 7%.

Benz: Sent us into bubble territory at that point.

Bogle: Yeah, it got us into bubble territory. So in those two decades the markets had returns of about 17% a year. But if you had even the most general idea that having gone from 10 to 20 to 40 times earnings, the next decade would have to go to 80 times earnings to continue those returns, you’d realize there was just a lot of air. That’s what valuations can get to in bubbles. So, putting all that together, we’re looking ahead–we’ll deal with stocks here first–we’re looking ahead to some challenges compared to what we’ve had in the past. So, today the dividend yield is 2%, the previous 50-year average or so is like 3.5% dividend yield, and that’s a dead-weight loss of 1.5% in return. You can make it up in other places, but you can’t make it up there.

Benz: Relative to past history.

Bogle: And the growth in earnings over the past 50 years has been about 6.5%. I don’t think it’s going to be that high. So I use 5% for earnings growth and that gives me roughly a 7% investment return on stocks. Those are pretty anchored, because we know the dividend yield, and earnings growth is such that you know we could have a 2% earnings growth and we could have a 10%, but we are highly unlikely to have zero and we’re highly unlikely have 20%. So there is a sort of centrality to earnings growth. So the problem is in the valuations. And today the stock market is selling at about 23 times earnings and the long-term norm is 17 times earnings, a little bit below that actually. And that would cost you 3% if the market ended this decade–I don’t do this for anything but decades; it doesn’t work at all year-by-year, but that would mean you’d lose 3% of that return.