Save, Invest, Build Wealth

Is a 7% Future Long Term Return Achievable?

By in Asset Allocation, Bond, Investing, Reader Question, Stocks | 15 comments

Asset Classes Matter

In a previous article, I received the following comment, which inspired me to answer the question, “Is a 7% future long term return achievable?”

Little House commented:

“I like how you broke down the asset classes percentages of stocks and bonds. Do you really think we can expect an average return of over 7 percent over the next 30 years? My husband and I were just discussing how savings rates are so low and have been for 10 years. We remember when we were kids in the 80′s that they were up to 12 percent! We can’t fathom them returning to this rate any time soon. Of course, savings rates aren’t the same as stock returns, but still. Am I being to gloom-and-doom? Will we see these returns again? I hope so!”

How are Stock Market Returns Created?

Economic growth is propelled by innovation, commerce, and invention. Economic growth advances corporations and leads to higher stock prices.

 Click here if you want to solve your investing problems. 

Here’s how it works:

  • A company creates products and services.
  • Individuals and other companies buy these items.
  • Eventually the goods and services may be sold internationally.
  • The company makes more money and gets bigger.
  • As the company grows, they purchase more from others just as others are buying from them.
  • Then, the company sells shares (ownership in their firm) to the public and the stockholders can participate in the profits (losses) of the company.
  • Investor’s benefit from growing companies by purchasing stock (and bond) investments from the company. Mutual funds or ETFs that hold growing companies allow investors to participate in the growth.
  • The investors make money 2 ways. First, as the firms sales and profits increase, the stock price also goes up. Second, the company may pay out some of its net income to the shareholders in the form of dividends.

This is the stuff that “economic growth” is made of.

 Is a 7% investment return achievable?

Growing companies create more wealth in the participating economy. With globalization, its easy for those in Europe or the U.S. to benefit from growing companies in Brazil or India.

Smaller companies can grow faster than larger ones. And smaller (developing) countries can grow faster than larger ones.

Is a Seven Percent Future Return Possible?

Assume you have asset classes in your investment portfolio consisting of stock and bond index mutual funds (or ETFs). Make certain to include some international index funds as well. Diversify the international funds with holdings from developed and emerging markets.

Diversified asset classes in the portfolio increase overall return while keeping risk to a minimum.

Consider these questions and answers to determine whether a 7% investment portfolio is possible in the future.

Will interest rates on bonds and cash increase in the future? It’s likely that interest rates will rise since they are at a historical low point.

Will China, India, and Brazil continue to grow rapidly in the future? There is little evidence to suggest their rapid growth is over. These emerging markets (and others) with quickly growing economies will offer higher stock market returns than the slower growing countries.

Will European and North American markets continue to grow? As long as these developed markets continue to innovate and grow goods and services available for consuming and exporting, they will expand.

Rationale For a Future 7% Long Term Return

I am not a soothsayer, but if I had to predict; the world economies’, over the long term will expand. Will they falter at some points? Absolutely economic growth will falter, economic growth is cyclical. From 2007-09 the U.S. had a recession. In 2014-15 the Eurozone is struggling economically.

Recently, the U.S. has experienced several years of stock market growth, so don’t be surprised when investment returns go down at some period in the future.

Interested in building long term wealth? Then click here and learn the smartest way to invest.

History has rewarded those who invested in stocks and bonds. If you have more than ten years until you need your investment funds, and world markets continue to grow, a balanced allocation in diversified asset classes of stocks and bonds representing various size companies from around the world could very likely reward you with a 7 percent annualized return.

Be aware that although long term stocks delivered higher returns, there is no guarantee about the future.

And if you’re looking for higher returns on cash, eventually interest rates will increase. And when they do, so will returns on cash assets.

If you hold an investment portfolio with both U.S. and International stock index funds, bond index funds and a bit of cash, it’s possible to obtain a long term 7% rate of return. If historical returns continue, and you hold 65% stock assets, 30% bonds, and 5% cash, and historical returns continue into the future, then your return average annual return would be 7.86%. 

Now, in response to the original question, “Is a 7% long term return achievable?”- with a diversified portfolio, yes. With only cash investments, t’s unlikely to obtain a 7% average annual return.

For reference, here are long term rates of return for various asset classes:

historical asset class returns

Action Steps:

1. Invest in your workplace retirement account today. It is the easiest way to invest and build wealth.

2. For speedy asset growth-invest the maximum amount allowable by law into your workplace retirement account (or a Roth IRA) in a portfolio of diversified asset classes.

3. Rebalance the asset classes allocations every year.

Do you believe a future 7% return on a balanced portfolio is plausible?

a version of this article was previously published

    15 Comments

  1. A 7% return is reasonable for the next 30 years! Understanding that return is an average, there will be ups and downs not unlike we have seen in the last few years. In my case, I do not have a 30 year horizon. My plan may require a more conservative approach.

    krantcents

    June 22, 2011

  2. I think 7% is doable, but whenever I get into the discussion with someone, I let them give me the number and then provide the calculations.

    So if I were having that discussion with LH, I would say something along the lines of “I don’t know, but what number are you comfortable with? Just so we can project something”

    Evan

    June 23, 2011

  3. @Krantcents-Thanks for adding in the “personal” component. It is so important to understand your own time horizon (and risk tolerance).
    @Evan- I like this approach, it allows for titrating based upon ones personal risk tolerance or one’s ability to tolerate the ups and downs in investment portfolio value!

    Barb

    June 23, 2011

  4. Thanks Barb for replying to my initial comment. Your analysis definitely makes sense; emerging markets will continue to grow for a while and there’s always ups and downs in the stock market. However, I guess if I had to predict a growth rate myself, as Evan mentioned, I’d be on the more conservative 5% side. 😉 Then it would be a happy surprise if it grew by 7% instead!

    Little House

    June 23, 2011

  5. It definitely is possible! Will it all come from this hemisphere is hard to tell. You can’t predict or control this, the best you *can* do is to have a balanced portfolio. Save religiously and keep re-balancing.

    Not a new or a radical idea, but a time-tested one that’s worked well for many.

    MoneyCone

    June 23, 2011

  6. LH,

    Remember that is 5% (or 7%) AFTER TAXES…so you are really talking about 7 to 9% depending on tax bracket

    Evan

    June 23, 2011

  7. I think over the very long run it is doable – like you said 30 years. I think it is going to be a very rough short term, and a better medium term.

  8. @Little, Evan, Money, and Robert- You all are quite realistic and aware that investing in a diversified portfolio of stocks (national, and international), bonds,and maybe a bit of real estate is the LONG TERM road to wealth. The short term is anybody’s guess!!! Thanks Evan for mentioning taxes, we can’t forget about them.

    Barb

    June 23, 2011

  9. Innovation typically comes from the young. China and the US and multiple other countries have an aging populations (of which I am a part!). The world economies – as you noted above expand on growth of new companies and products which in turn require innovation to develop.

    If I had that 30 year horizon, I would want to extend beyond stocks and have my assets spread across multiple and diverse types of investments and geographic areas and I would want to be involved in my own start up or the start up of someone I felt had a good chance of taking off.

  10. @Go Marie- If you have some discretionary funds- go for it! Young companies have much greater room for growth than large and established companies (and countries).

    Barb

    June 25, 2011

  11. The methodology you laid out is probably the best way to get a long term 7% return. Because we are talking about a lower return than past history, we should also add that expenses matter. People should not invest in assets for which they will be charged more than 1% per year, and less is even better.

    Bryce @ Save and Conquer

    September 30, 2013

  12. Hi Barbara,
    If you have a long enough time horizon I invest the bulk of my money in small and mid cap stocks. Those often get overlooked, everyone talks about the highs of the S&P 500 this year but mid caps achieved their highs last year.

    Charles@gettingarichlife

    October 1, 2013

  13. @Bryce, EVery cent spent on fees is money not going towards investing. Most index funds and index ETFs sport fees below 0.20%. That translates into a lot more money going towards compounded returns.
    @Charles-Actually, one of the market anomalies of the efficient market hypothesis support historic outperformance of small and mid caps. But there are periods of time (and they may be long periods) when small and mid caps don’t outperform. Thus, I suggest making sure you have at least some allocation to large caps and international stocks in the equity portion of your portfolio.

    Barbara Friedberg

    October 1, 2013

  14. If one also incorporates past data into the equation, I think it’s certainly possible that 7% returns are achievable. It’s not far off from what has been seen since 1970 at least. Though there are some multi-year periods in there that are much better than others.

    Really, one must focus on achieving an overall rate of return that’s going to grow net worth. If we consider the effect of inflation from a 7% return, the net is more modest. It’s vital to maximize that gap between returns and inflation, and this generally means taking on some investment risks as a part of a balanced approach across asset classes.

    Squirrelers

    October 1, 2013

    • Hi Squirrelers,

      Thanks for bringing up inflation. Although it has been tame in the past few years, the historical inflation average is about 3 percent. Thus, as you so aptly stated, one must take a bit of risk in their portfolio in order to get a real (inflation adjusted) return.

      Barbara Friedberg

      October 2, 2013

Trackbacks/Pingbacks

  1. I BONDS DEMYSTIFIED; GET GOOD RETURNS ON YOUR CASH | Barbara Friedberg Personal Finance - […] heard the rhetoric. If you’re young, invest in stocks. They have the greatest possibility of growing your money long…

Post a Reply

Your email address will not be published. Required fields are marked *