The Market is Down: Your Expected Investment Returns Just Went Up!
Near the end of 2007 as the market was hitting new highs, I wrote a post that was titled exactly opposite of today’s post. (As the market was hitting highs, our collective expected returns were going down.) After the rather dismal financial news recently I thought it was a good time to remind readers of the good news that is implied when the prices of assets go down in value.
If this does not seem intuitive that your expected returns rise as prices go down, let me use an example. Most investors are taught that the stock market has historically provided a return of approximately 10%. So, let’s assume that at the beginning of 2022 you held the expectation that the next 10 years would provide exactly that 10% investment return on your portfolio. To keep the example simple, let’s say the portfolio was valued at $100,000 at the beginning of this hypothetical 10-year period. While not realistic to get exactly 10% every year, this portfolio would grow to be worth just under $260,000 after the 10-year period.
Now, let’s change the first-year return to a loss of 23%. (As I write this the S&P 500 is down that amount so far in 2022.) At the end of the first year in this example the portfolio would be worth $77,000. How much does the portfolio have to earn going forward on an annualized basis in the next nine years to get it to $260,000 at the end of the original 10-year period? Answer: nearly 14.5%
This 14.5% is now your new expected return for the next nine years now that you have gone through a particularly poor first year. I know what you are thinking: there is no way I can adjust my expectations after what we have seen so far this year. While that would be completely normal, you should also be on guard for recency bias. (We tend to weight more recent news in our minds much more than news from the distant past, or future!)
Of course, I am making absolutely no predictions here. Any one with any sense should admit they have no idea what the market behavior will be in the future, because the future is always uncertain. But I do think it is reasonable to put the current market downturn in perspective and understand that expected returns do rise after prices go down. Unfortunately, those expected returns are not guaranteed, and they are not guaranteed to occur within a time frame that any of us might prefer.
When we think about our financial condition there are certain things we can control: our spending is one example. Another thing we can control is the strategy we use for our investment portfolio. As all our clients know, we strongly recommend a written Investment Policy Statement be in place before beginning an investment program. This policy can then serve as a guide as to what to do when markets are going up, and when they are going down. If you are concerned about your current financial situation and you do not have a written Investment Policy Statement, I do recommend you consider working with a fee-only financial advisor.
Weingarten Associates is an independent, fee-only Registered Investment Advisor in Lawrenceville, New Jersey serving Princeton, NJ as well as the Greater Mercer County/Bucks County region. We make a difference in the lives of our clients by providing them with exceptional financial planning, investment management, and tax advice.