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The vibe of future returns: tell ‘em they’re dreamin’

In the iconic Australian film, The Castle, during the classic court scene, the family lawyer, Dennis Denuto, is struggling to make his case, bumbling around with a copy of the Australian Constitution. Finally, he sums up in a segment that has both entered Australian folklore and become required viewing for law students:

“It’s the vibe of it ... It’s the Constitution. It’s Mabo. It’s justice. It’s law. It’s the vibe and … ah, no, that’s it. It’s the vibe. I rest my case.”

The Constitution has little relevance to his case. It was simply the vibe of the thing.

There’s a similarity now with the assumptions used in calculating future superannuation balances. There's a general vibe drawn from prior performance that is now more like wishful thinking. Let’s consider what a realistic long-term return on superannuation should be, and not just a vibe from the past. This article is not a general review of how the calculators work.

Why bother making forecasts?

Retirement planning should start decades before the end of full-time work, to gain an understanding of how much should be saved to achieve a desired living standard. An assumption about nominal and real rates of return will show how much the market will deliver in addition to capital invested.

In a wonderful world of returns well in excess of inflation rates, driven by compounding over long periods, bond and equity markets will provide the financial resources for a comfortable retirement far quicker than if returns struggle to beat inflation.

This article will focus more on the next 10-year horizon than the truly long term, where it may be possible to generate the strong market performance of the past. But that belongs in the category of a ‘nice problem to have’ given the impact of climate change, technology replacing jobs and a rapidly-ageing workforce over a longer-time period.

Superannuation balance calculators usually assume a nominal rate, then discount the future amount by an inflation factor, currently about 2.5%. In this discussion, 7.5% nominal and 5% real are considered approximately the same. 

‘Two cents’ worth’ on super projections

The most popular website for starting to understand investing, including superannuation, for many Australians is Moneysmart, administered by the Australian Securities and Investments Commission (ASIC). It is an excellent resource for all aspects of money management, especially for beginners.

It includes a superannuation calculator designed to determine how much super a member will have when they retire. The inputs include age, income, desired retirement age, super balance, employer contributions, personal contributions and fund fees.

The default investment return is set at 7.5% (before taxes, fees and inflation), updated as at 17 April 2020. It uses Treasury’s long-term retirement income models based on 2019 modelling assumptions from this paper. Curiously, as if they realise the number is a stab in the dark, the link is called ‘Treasury’s Two Cents’.

Similarly, every major superannuation fund provides its members with some type of online calculator, such as AustralianSuper, Australia’s largest super fund, updated in April 2020 based on the following assumptions:

Over 90% of AustralianSuper’s members choose the ‘Balanced’ option, with an objective of CPI plus 4% and an investment timeframe of 10 years. This is currently positioned towards 'high' in the table above, so let’s call the return assumption 7%. The option’s permitted asset allocation is wide, allowing a defensive stance of up to 45% in cash and fixed interest or an all-out aggressive stance of 90% to 100% in equities. At the moment, cash and fixed interest is only 15%.

With Moneysmart at 7.5% and a leading industry fund at around 7% for the default option, the question must be asked: Are they dreaming?

Sorry, Millennials and Gen-Z, these returns are in the past

The most obvious factor reducing future returns is the fall in interest rates. Global and Australian markets are at the tail end of a 30-year bull market in bond rates, and in fact, rates peaked at 16.4% for 10-year Australian Treasury rates in 1982. This has not only delivered handsome coupons but strong capital gains on the so-called defensive part of the asset allocation. It has made fixed income and to a lesser extent, cash, an attractive part of the asset allocation.

However, the starting point for future returns is a cash rate and bond rate of 0.25%. The Reserve Bank has signalled ultra-low bond rates for many years to come, driven by the imperative to recover in a post-coronavirus world.

The strong result is that between 1950 and 2019, the 20-year rolling returns (in nominal terms, not adjusted for inflation) for the S&P500 has varied between 6% and 17% per annum and a 50/50 blend 5% to 14% (Australian market returns would be marginally less). 

That’s a retirement tailwind that should go straight to the pool room.

In the context of these returns, the assumption of earning 7% looks fine. But these were glorious investment conditions enjoyed by Pre-Boomers, Baby Boomers, and to some extent, Generation-X. Unfortunately Gen-Y (the Millennials) and Gen-Z are unlikely to have it so good.

All that matters now is the future

Anyone investing now cannot live on past returns. While there are as many forecasts in the world as there are economists, let’s draw on four forecasts to glimpse into the future.

1. Elroy Dimson and the London Business School

The Global Investment Returns Yearbook has been published since 2000 and has become a global authority on long-run asset returns. It provides a 120-year review of the risk and performance of the main asset categories in 23 countries in North America, Asia-Pacific, Europe and Africa. It includes a forecast of future returns as an econometric derivation of the data.

Its current edition quotes the lead author, Professor Elroy Dimson (for my 2014 interview with Elroy, see here) forecasting lower future returns because:

“It’s real interest rates that provide the baseline for all risky assets, and when real interest rates are low, so are expected returns.”

In real terms (adjusted for inflation) interest rates today are effectively negative, other than when credit risk is taken. Professor Dimson, together with his colleagues Professor Marsh and Dr Staunton, expect prospective real returns from equities to be somewhere in the region of 3.5%. However, in a typical 60/40 balanced portfolio used for the default option in most Australian super funds, 40% of the portfolio in fixed interest will probably contribute little.

This means the future balanced portfolio may deliver a real return of only about 2% a year.

Dimson argues that in this low-return environment, it is even more important for investors to reduce the amount they pay in fees. The Yearbook provides the following chart to show how the generations have fared. Returns have fallen over time, but the future is the worst.

Global Investment Returns Yearbook, 2020 edition, likely future returns

Reproduced with permission from The Global Investment Returns Yearbook, written by Elroy Dimson, Paul Marsh and Mike Staunton. Copyright © 2020. See acknowledgement at the end.

2. Robert Shiller's implied future market returns

Nobel Laureate, Professor Robert Shiller of Yale University, invented the Shiller Price/Earnings (P/E) Ratio and it has become a standard to measure the market's valuation. This is not the place for a full study of it, but further details are available here and his data base is here.

The Shiller P/E 10 in the table below eliminates some of the fluctuations caused by business cycles (10 refers to the average of 10 years of earnings).

As at 4 May 2020, the current Shiller P/E of 27 was 57% higher (the red line above) than the historical mean of 17 (the black line above). An estimate of the future stock market return then comes from three factors: 

  1. Contraction or expansion of the Shiller P/E to the historical mean
  2. Dividends
  3. Business growth

Based on the current Shiller P/E level, using this method to calculate the future stock market return, gives around 0.2% (real) a year. (For source and more information see Gurufocus).

The 0.2% is derived from reverting to the mean, and it will take a 'really lucky' result of 150% of the mean to deliver a nominal 5% from today's levels, as shown below. 'Really unlucky' does not bear thinking about.

The market is expensive and this will reduce future returns. However, Shiller places it in the context of the alternative of the extremely low rates on bonds. He wrote in The New York Times on 2 April 2020:

"On balance, I’d emphasize that the stock market is not as expensive as it was just a month ago. Based on history, we would expect to see it to be a reasonable long-term investment, attractive at a time when interest rates are low."

3. Research Affiliates' interactive forecasts

The work of Research Affiliates and its expected return models is notable for its interactive website, allowing investors to check forecasts across a wide range of asset classes, as well as standard deviations and the probabilities of forecast accuracy.

Here is a sample of its 10-year expected returns, plotted against expected volatility. While there are some assets above the 5% real return line, they are mainly in Emerging Markets (EM) where Australians rarely invest. Most traditional markets offer small real returns.

Research Affiliates’ Selected Returns for 10 years, as at 31 March 2020

These real returns offer little prospect of achieving the 4% to 5% assumed in superannuation calculations.

4. Schroders Australia

Differences of opinion make a market, and for every buyer, there's a seller. So we reached out to Schroders Australia for a local perspective, and they are more optimistic.

For Australian equities over the next 10 years, updated as at end of April 2020, the forecast is 10.2% (nominal), made up as follows:

In other asset classes, forecasts are 4% for US equities, 6% for global equities, 7.5% for A-REITs and 1% for Australian Government Bonds. This means an allocation of 60/40 (say 30% global equities, 30% local equities and 40% bonds) is forecast to deliver about 5.25% nominal, or 2.75% real.

What should a superannuation member do?

The first step when using a calculator to plan for a future retirement is to be realistic. For all the expert opinions, personal judgement is the final arbiter. For extra security in retirement, instead of expecting 5% above inflation (or a vibe of 7% to 7.5% nominal), aim for closer to 2% to 2.5%.

Planning should not be based on a short-term buying opportunity in the pandemic, but taking a longer-term view across many investment cycles. Shares are down only about 15% and back to early 2019 levels. Markets are trading above their long-term price-to-earnings ratios, and are likely to produce relatively poor returns for at least a decade.

The outlook affects all generations, but in different ways. Baby Boomers who have already built their retirement savings will need to watch drawdown levels, as spending 5% of a pension fund might erode capital quicker than expected. Millennials and Generation Z who are saving may need to put more into superannuation or work longer than their parents to achieve the same balances.

This comes at a time when the costs of bailing out countries from the coronavirus will need to be repaid. In Australia, the $400 billion of virus deficits will hang over future economic growth as governments look to repay debt. While the spending in 2020 is right to support the economy and people in need, the federal government cannot continue to pay the wages of millions of unemployed. Australia will swing back towards a period of fiscal restraint. It’s also likely that spending on health and aged care will ramp up, at the same time as Australia wants to return to a market economy.

The potential for future tensions is obvious. Many people in older generations have benefitted from negative gearing, tax-free capital gains on their family homes, favourable property prices, strong stock and bond markets and lightly taxed savings in the form of superannuation. The calls for increasing pensions, health and aged care spending also predominantly benefit retirees. The social contract between generations will be challenged.

The reality is that return for risk payoffs are now lower. The average long-term expected outcome is reduced but the range of possible outcomes is just as wide, which means a larger proportion of potential outcomes may be unacceptable.  But de-risking involves a greater acceptance of a lower average return.

The best way to minimise the impact is to ensure as much financial self-sufficiency as possible, which begins by not deluding ourselves about future returns.

Here's some final words from Robert Shiller's April article:

"As a practical matter, my advice is to look at your portfolio to make sure that it is not so heavily weighted to stocks that further losses would be unbearable. Otherwise, I’d try not to worry too much about the stock market. Most likely, it will do moderately well in the coming years, even if there is a risk that you will need to be very patient."

If someone offers a 7.5% future return on a balanced fund, while there may be a temptation to say "That’s going straight to the pool room", in reality, it should be "Tell 'em they're dreamin'".

What do you think? Use the comments section to add your view.


Graham Hand is Managing Editor of Firstlinks. This article is general information and does not consider the circumstances of any investors.

To obtain permission to reproduce the Yearbook chart, contact the authors at London Business School, Regents Park, London, NW1 4SA, United Kingdom. At a minimum, each chart and table must carry the acknowledgement Copyright © 2020 Elroy Dimson, Paul Marsh and Mike Staunton.


May 12, 2020

Thanks for the analysis Graham, love reading your articles. From what I can see the Moneysmart calcs discount to PV using a rate of 4% (not using CPI of 2.5%. or even the 3.2% typically used). Using their assumptions the gross return of 7.5% becomes 6.185% after fees and taxes. So essentially the projection is using a "real" return of 2.185%. This is before the admin fee and insurance costs are deducted. I wonder if ASIC are using the higher discounting rate offset the ambitious headline return figure.

May 10, 2020

Graham I had read from your 20 year lessons to Self that a fund with unlisted assets or alternative investments helps to manage reactions to volatile times so I was content with Hostplus Balanced fund with no cash or fixed interest but as it has fallen far greater than other balanced funds I am now having to work on my reactions.
Seems a Balanced fund by name only with all growth assets and not defensive in this environment. 
Any comment appreciated. 

May 10, 2020

Great article Graham. Why aren't there more people like you who can look at these issues without a bias. Thanks keep up the good solid analysis.

May 08, 2020

Along with others here I have retired in the last few years. Investment returns outside the family home had little to do with being able to afford to retire early, it all came down to saving. Anywhere up to 50% of salary at different times. If what Graham says come true, then this will be even more important in the coming period.

Graham Hand
May 08, 2020

Hi Al, yes, saving more for longer will need to do the heavy lifting rather than relying on markets for future long-term plans.

Peter Herington
May 07, 2020

One of the best, balanced articles you've written and/or I've seen in the current environment.
Great work. Regards

Graham Hand
May 07, 2020

Thanks, Peter. Appreciate the feedback, good to hear from you after all these years. G

May 07, 2020

Sorry, but I respectfully and completely disagree to state that essentially, the returns for Gen-X (we are still working towards retirement, thank you), Y, Z and millennials are maybe 7% going forward ad infinitum.

Particularly when we look at over 30 years and instead, look at the longer term, rolling 40-year periods - representative of the working years of a typical person - share returns have been remarkably stable in a range around 12 per cent (Source: ASX website).

"The Reserve Bank has signalled ultra-low bond rates for many years to come" - OK, but that means that capital has never before been cheaper and so the incentive to open a business and take on more risk would therefore be much better than before. If I can borrow money at 2% and invest it in a property and get 4-5% rent, tax breaks and a free kick on capital growth (which I can), it's a no-brainer.

Plenty of people have been wrong making big predictions like this. Yale economist Irving Fisher said “Stock prices have reached what looks like a permanently high plateau,” and was completely wrong.

Don't forget “Dow 30,000 by 2008: Why It’s Different This Time,” written by Robert Zuccaro

"Bear Sterns is fine. Don’t move your money from Bear, that’s just being silly.” - Jim Cramer (When Cramer spoke on 3/11/2008, Bear was trading around $60 per share. The stock opened at just over $3 per share on Monday 3/17/2008 after JPM made their purchase over the weekend.)

"Netflix Overvalued" by Paul La Monica. NFLX was trading at $10.98 per share; the stock is now trading above $300 per share, a gain of over 4,000%. And let’s not even mention NFLX’s all-time high cracked $450 per share.

"Dow Could Crash to 3,000 in 2013" by Harry Dent. It never did, no crash ensued and the Dow went on to have its best year in over a decade.

“I believe that it is virtually certain that Google’s stock will be highly disappointing to investors foolish enough to participate in its overhyped offering — you can hold me to that.” - Whitney Tilson. We all know what happened next.

David M
May 29, 2020

Good luck getting 4-5% rent on residential property. I had several investment properties - almost fully paid for - and realised that the rent I was getting over a lot of years was somewhere between 0.7% and 1.6% of the value of the property. Because almost fully paid for, negligible negative gearing benefits, and even if there had been, they are much less than they used to be. The only real benefit was the capital gain which was on and off depending on the real estate market. I have been gradually disposing of the properties.

May 07, 2020

She'll be right mate. Another line from The Castle, slightly misquoted:
"Dad reckoned that [investing] was 10% brain and 95% muscle and the rest was just good luck."

May 07, 2020

They say you can't time the markets - but boy, I'll try! Super switched to Cash and it's staying there for now...

May 15, 2020

me too with my super dropped 52k but i wonder when is the right time to go back to balanced

May 07, 2020

I have just retired, brilliant timing. My intention has been to mainly live off the income produced from investments and add a percentage of the total growth assets (around 1.5%). The rationale is that the historical growth in the market has been around 5% p.a. so taking 1.5% leaves 3.5% growth, still keeping the asset base slightly above inflation. The 1.5% figure could grow but being fresh into retirement a more conservative course seems good to start. Of course if the asset base falls 1.5% of this falls. And even more obvious, dividends will fall in the next year at least. It all relies on balancing expenditure with income; if income falls so must expenditure, or you have to eat into capital. Same applies if a two income family loses an income, they adjust their expenditure (where possible). Or any small business, income in any year will go up and down and you have to adjust. The idea that the income produced by assets which provides your pension is fixed and you can spend the same amount year in year out is clearly wrong. The impossible bit is knowing how much and how fast you can start to consume capital, the old richest person in the cemetery risk. Taking just 1% extra capital gives a not-inconsiderable boost to spending (today) for a lower income later.
Last bit. Researching investment philosophies exposed me to the concept of skewness, where the vast bulk of returns for stock markets come from a rather small number of stocks (which is why most professional funds don't even match the index). Index funds generally do better simply because they are more likely to hold the "winners". If a fund manager years ago decided Myspace was going to beat Facebook, they would look pretty silly now, but the point is back then who was to know the winner? So, the point is, hold index funds as the winners from the new economy may look very different to the ASX200 today.

May 07, 2020

Agree with the sentiment Graham. 7% nominal seems quite ambitious in light of the research you've presented. Seems to be much easier to assume a generous discount rate and hope the markets do the heavy lifting than to face the prospect of saving more, working longer, selling other assets etc etc. Human nature I guess..

May 07, 2020

always a great read. my super dropped 52k and i am in australian super balanced. i feared further losses as i am close to retirement so i moved it to cash. now i am wondering if we have hit bottom or not and should i move it back to the balanced option ? any advice appreciated cheers

Graham Hand
May 07, 2020

Hi Paul, thanks for the comment. We are not licensed to give personal financial advice, so this is a general comment. Nobody knows how Covid-19 will play out, you can find market experts who say buy, hold or sell. No idea if we have hit bottom. Generally, a person's super exposure to volatile markets should match their appetite for risk, and then take a long-term view. Anyone close to retirement should be thinking in terms of decades, not the next few weeks or months.

Gary M
May 07, 2020

The disconnect between the stock market and the economy is so strong that we're behaving as if it's business as usual, not staring at an earnings black hole.

May 07, 2020

Given what is happening in the world, if you gave me 5% for the next 20 years, I'd take it.

May 07, 2020

Retired just before we knew about Covid-19. My SMSF has dropped dramatically, as has my industry fund. I bought a few shares a couple of weeks ago hoping that they may offset some of my losses. Don't know if I will live long enough to enjoy a rebound. It took 10 years to recover from the GST and this is far worse.
If you find that 5% for the next 20 years Jack can you please let me know :-)


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Short version of future returns article: dreamin' on


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