This Day On The Street
Continue to site right-arrow
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

Planning for the Lean Years

If the past two years' losses have lowered your expectations for stock returns, you might want to keep them there -- or even take them down another notch.

Related Stories
The Big Screen: The Buffett Way
Big Screen Archive: Solid Funds and How They Fit Together

That's the message from financial planners, fund managers and even Warren Buffett. Through the 1980s and 1990s, stocks rang up an 18% average annual gain, according to data from the Charles Schwab Center for Investment Research. That's far above the 11% historical average. The past two years' losses might lead you to expect a surge back to 1990s-type gains. But with a sluggish economy, interest rates due to rise and stocks looking far from cheap, experts are seeing more reasons for stock returns to stay below 11% than above it in coming years.

"If someone came to me and said, 'I have to make 15% a year over the next decade,' I'd tell them there's no way to do it," said Bill Nygren, manager of the (OAKMX) Oakmark fund and the reigning Morningstar fund manager of the year. Citing slower growth and high stock valuations, Buffett wrote that he had "lukewarm feelings about the prospects for stocks in general over the next decade," in his annual letter to shareholders of his holding company, Berkshire Hathaway (BRK.B), last week.

The upshot for fund investors: Sock away more money and expect lower growth. Slimmer gains shouldn't make you abandon stock funds, but they are reason to save more, spread your bets and stick with cheap, tax-efficient funds. If you're prudent now, you'll still reach your goal, and if stocks do exceed your expectations, then you'll be saddled with the pleasant problem of having extra money.

Let's look at why we might see lower gains than we saw in the 1990s and then how we might invest accordingly.

Part of the case for lower gains over the next year are all those gains we've already seen. Yes, stocks have lost ground and trailed bonds over the past two years, but those lousy years cap a stretch of breathtaking gains. Thanks to low interest rates, a solid economy and surging confidence in the equity markets, the S&P 500 gained more than 20% each year from 1995 through 1999, its finest five-year stretch ever. A $10,000 investment in the (VFINX) Vanguard 500 Index fund, which tracks the S&P 500, at the start of this period would've grown to more than $35,000 by its close, according to Chicago research house Morningstar.

"We have to pay for the excessive returns we've seen," says Steve Henningsen of Boulder, Colo.-based financial adviser The Wealth Conservancy. "You just can't get 20% returns year in and year out."

Even with the last two years taken into account, stocks have still averaged a 13% annualized gain over the past 10 and 15 years, through Feb. 28.

What Now?
Experts aren't sure stocks can keep up their white-hot pace
11%, stocks' historical annual return. SSource: Charles Schwab Center for Investment Research.

And though the S&P 500 is down 21% over the past two years, a collapse in corporate profits have kept stocks' valuations far from cheap. The stocks in that index are trading at some 23 times their expected earnings over the next 12 months, according to Thomson Financial/Baseline. That's still well above the index's historical average price-to-earnings ratio , which is about 15.

"I'd say the S&P 500 doesn't look grossly overvalued or grossly undervalued," said Nygren, given current low interest rates and inflation.

If interest rates rose steadily, corporate profits would shrink, making investors less willing to pay up for stocks. The winded state of the U.S. economy will hardly spur companies' earnings or investors' appetite for stocks either.

So it's not surprising that Nygren expects stocks to average a 7% or 8% annual return over the next decade. In today's 10 Questions interview , financial planner Harold Evensky makes a similar forecast. And in Buffett's annual report, the Omaha Oracle disclosed that he expects a 6.3% long-term return for the stocks and bonds mixed in the pensions of companies Berkshire Hathaway owns.

Gloomy as they are, these forecasts aren't reason to quit investing in stock funds. There will undoubtedly be bursts of hot performance for individual stocks and the broader market, too. And there's a dearth of better options out there that you can use to save for retirement. Yes, bonds are less risky, but they usually return less than stocks. Nearly riskless money market funds barely keep up with inflation. So unless you're a real-estate wiz or have come up with the next Pet Rock, you're probably stuck with the stock funds offered in your brokerage and/or 401(k) account.

This creates a potentially dangerous situation. Given the potential for lower gains overall, you might feel the urge to bet the farm on the riskiest fare like emerging-markets stocks, small-cap stocks or high-yield. Each will have their days in the sun and each can play a modest role in your portfolio. But for the vast majority of investors, a lower-return environment is reason to follow the oldest saws in the book:

  • Save more : Lower returns mean you have to invest more to reach your goal.

  • Diversify: Spread your assets across the fund world's sectors and styles, using our portfolio blueprint as your guide.

  • Pay attention to taxes and fees: Index funds and some actively managed funds have a knack for avoiding taxable capital gains distributions and steep fees -- both of which are a lot more noticeable and irritating when you're earning 7% a year rather than 20%.

  • The bottom line is that the only thing worse than losing money on an investment is making far less than you expect or need. Ratcheting down your expectations and ramping up your savings will help keep you out of this nasty bind.

    Ian McDonald writes daily for In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to, but he cannot give specific financial advice.

    Select the service that is right for you!

    Action Alerts PLUS
    Try it NOW

    Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

    Product Features:
    • $2.5+ million portfolio
    • Large-cap and dividend focus
    • Intraday trade alerts from Cramer
    • Weekly roundups
    TheStreet Quant Ratings
    Try it NOW
    Only $49.95/yr

    Access the tool that DOMINATES the Russell 2000 and the S&P 500.

    Product Features:
    • Buy, hold, or sell recommendations for over 4,300 stocks
    • Unlimited research reports on your favorite stocks
    • A custom stock screener
    • Upgrade/downgrade alerts
    Stocks Under $10
    Try it NOW

    David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

    Product Features:
    • Model portfolio
    • Stocks trading below $10
    • Intraday trade alerts
    • Weekly roundups
    Dividend Stock Advisor
    Try it NOW

    Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

    Product Features:
    • Diversified model portfolio of dividend stocks
    • Alerts when market news affect the portfolio
    • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
    Real Money Pro
    Try it NOW

    All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

    Product Features:
    • Real Money + Doug Kass Plus 15 more Wall Street Pros
    • Intraday commentary & news
    • Ultra-actionable trading ideas
    Options Profits
    Try it NOW

    Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

    Product Features:
    • 100+ monthly options trading ideas
    • Actionable options commentary & news
    • Real-time trading community
    • Options TV
    To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
    Submit an article to us!


    DOW 17,804.80 +26.65 0.15%
    S&P 500 2,070.65 +9.42 0.46%
    NASDAQ 4,765.38 +16.9840 0.36%

    Brokerage Partners

    Rates from

    • Mortgage
    • Credit Cards
    • Auto

    Free Newsletters from TheStreet

    My Subscriptions:

    After the Bell

    Before the Bell

    Booyah! Newsletter

    Midday Bell

    TheStreet Top 10 Stories

    Winners & Losers

    Register for Newsletters
    Top Rated Stocks Top Rated Funds Top Rated ETFs