Unrealistic Expectations

Unrealistic Expectations

October 18, 2020
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When saving for retirement, it’s best to assume slightly lower returns than average to make sure you’re not relying on risky investments to save enough. Overly-aggressive return assumptions could well cause you to not have enough money to retire. Obviously, it depends your investment profile, age, and needs.

Expecting 6% returns on a globally diversified portfolio is not unreasonable.  But we’ve discussed before how bonds are increasingly a drag on even this number. Also, the market seems to be completely discounting valuation, and is driven primarily by stimulus probability. Is this sustainable? http://www.currentmarketvaluation.com/

People have an over-optimistic outlook on their total investment returns

According to a survey by Schroders, the expected 5 year average annual return in investment portfolios rose from 9.9% in 2018 to 10.7% in 2019 to 10.9% in 2020. That’s high. This survey was done from April 30th to June 15th this year. People probably would be even more optimistic if they were surveyed from August to October.

Optimism in the Americas is extreme; perhaps because the U.S. stock market led by FAAMG has had a great run. But what is the driving force behind these attitudes and unrealistic predictions? The results show that 80% of people are still basing their predictions on the returns they have received in the past, with a decade of strong returns potentially inflating people’s expectations to unrealistic levels. 67% of people corroborate their expectation of lower returns over the next five years, stating that they believed this to be the case even before the onset of the pandemic.

The consensus is usually wrong when everyone is on one side. US investors think their returns will be 15.38% annually in the next 5 years. This is an absurdly high forecast. The actual rate of return of the S&P before taxes and fees was 9.4% over the 5 years ending December 2019.  For the past 20 years, (2000-2019) the return is only 4%.

These investors clearly are heavily invested in their home country which has been doing well (home country bias). Even investment advisors who are aware of home country bias are saying that the only people who should be biased towards their home country are Americans.

Many are using recency bias to defend home country bias, which is a double mistake that can cost them money. Of course, there are reasons American stocks have done well in the past 5-10 years. However, mean reversion is real, and has a long track record. It’s not a strong argument to base your retirement forecasting on an allocation of a few large internet giants that have powered one country higher. Competition and regulations affect all companies. FAAMNG isn’t immune to risk. To be clear, we’re taking a long term view of allocation and expected returns when discussing these issues.