Tough Questions: Returns

I often find myself on the receiving end of some really tough questions. The questions are usually lobbed by curious clients. I sometimes find myself struggling to answer in a helpful manner.


It’s not that the answers are unknowable. Or that they are difficult to research. The problem is that there are multiple answers, a number of ways to truthfully answer the question. But not all of the answers, though truthful, are honest. Some answers are lying with statistics.


Here’s a great example. Clients often ask, “How much do you think this investment will earn?”


That’s a wonderful question. And the answer can be terribly dishonest.


To understand why, let’s talk about stock market returns. From 1928, when reliable data began, through 2019, U.S. large company stocks returned 9.7% a year. If someone asked what stocks could return over time, that’s a decent answer.


But the question could be answered differently, and yet still truthfully.


From 1990 to 1999, for example, large company stocks in the U.S. returned 18.4%. Going back even further, from 1982 to 1999 – an 18-year period – large company stocks in the U.S. produced returns of 17.1% a year. So, you could truthfully say stocks could return 17-18% a year.


But that would likely be a best-case scenario and probably not what investors should expect.


Stocks can certainly generate mouth-watering returns from time to time. But they can also backtrack periodically.


Even earlier this year, as the coronavirus was emerging, U.S. large company stocks lost 33.9% in a matter of five weeks. From November 2007 through February 2009, that same set of stocks dropped just more than 51% – cut in half in 16 months.


Those are relatively short timeframes. The numbers, however, are real. We can widen the lens, though, to provide a more appropriate timeframe. How about 15 years? That’s a reasonably long time.


From 1928 through 1943, a full 15 years, large company stocks in the U.S. returned (are you ready for this?) -0.2% a year. Be sure to note the negative sign.


Imagine that. You put $10,000 into large company stocks in the U.S. in 1928 and by 1943, 15 years later, your investment has shrunk to $9,724. You could have invested in super-safe bonds over that timeframe and transformed your $10,000 into $11,376.


That bears repeating. For 15 years, a risk-free investment beat the pants off a risk-filled investment.


And that’s just large company stocks in the U.S. Most portfolios have small companies, medium-sized companies, international companies, and bonds. Each of them behaves differently in different market environments.


So, you can see why such a simple question – how much do you think this investment will earn? – is incredibly difficult to answer honestly.


The best – and least fulfilling answer – is that it depends.


It depends on current investment valuations. It depends on the timeframe. It depends on what future investors will be willing to pay. It depends on the economic situation. It depends on the geopolitical environment.


As a result, when asked about potential returns, I find myself saying things like, “Over long periods of time – say 20 to 30 years – large company stocks in the U.S. are likely to return between 8-10% a year. But there will be times when they lose half of their value. And stocks could even have 15-year periods where they return approximately nothing.”


I know that is not exactly a pithy or satisfying answer for those asking the question.


But, frankly, it’s the honest truth.

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