Finally, stock prices should rise in line with earnings, which, in theory, can grow without limit. In practice, however, earnings growth is restricted, mostly by the growth rate of the general economy. With growth slow around the world as well as here in the U.S., an increase in earnings is also likely to be limited—another headwind.
Putting it all together
We know that, compared with history, we are losing about 1 percent to 2 percent per year from lower dividends. We know that valuations are about as high as they get and are unlikely to increase and boost our returns—and may well decline. And we know that earnings growth, the sole remaining return generator, is likely to be lower than it has been as well.
In other words, all of the things that generate returns are likely to disappoint. Small wonder that many savvy investors expect returns over the next several years to be lower than they have been in the past.
And one more thing: none of this takes into account the potential for a bear market. A sustained decline in the market would depress returns for some time, potentially bringing down average returns for a decade or more, as has happened in the past.
In today’s environment, of course, returns of around 4 percent don’t look all that bad, which is worth remembering. What should matter most to investors is not the level of absolute returns, but the gap between those returns and their expectations. As investors, we need to recognize the very real risk that the returns we get may be less than the returns we expect—and plan accordingly.
Brad McMillan is the chief investment officer at Commonwealth Financial Network, the nation’s largest privately held independent broker/dealer-RIA. He is the primary spokesperson for Commonwealth’s investment divisions. This post originally appeared on The Independent Market Observer, a daily blog authored by McMillan.