Personal Finance

'Ordinary' investors expect an 8.5 percent return

Retirees’ investing strategies
Retirees’ investing strategies

The second longest bull market in history has lulled Main Street into complacency.

U.S. investors expect their portfolios to generate an 8.5 percent return annually over the long term after inflation. Financial advisors said a 5.9 percent return is more reasonable, according to new research by Natixis Global Asset Management.

The mismatched expectations could mean investors are saving less than they should to reach their retirement goals. And it appears to be a global problem. (See map below.)

Individual investors, on average, said they would need to earn an annual return of 8.5 percent above inflation to achieve their investment goals. And 70 percent of those investors said they can realistically reach that level of return over the long term.

Millennials are even more optimistic, with investors between the ages of 18 and 34 expecting long-term annual returns of 8.7 percent.

Investor expectations were 44 percent higher than their advisors in the U.S. However, even with larger expected returns, more than three-quarters of investors said they would prefer safety in their investments over performance, according to the Natixis research.

"Advisors are more pragmatic than investors about their return expectations," said Dave Goodsell, executive director of Natixis' Durable Portfolio Construction Research Center. "Having unrealistic return expectations are among the top mistakes advisors say investors make."

Natixis surveyed 300 U.S. financial advisors in July 2016 and 750 U.S. investors with a minimum of $200,000 in investable assets in February. The research was part of broader global surveys that included 2,550 advisors and 7,100 investors from 22 countries this year.

Historically, an 8.5 percent annual return has been a high hurdle to clear for the U.S. stock market.

U.S. stocks have returned an annualized 10 percent from 1926 through August 2016, according to investment research firm Morningstar. Inflation during those decades has averaged 2.9 percent annually. That works out to an annualized 6.9 percent return when you adjust for inflation.

Many investors use historical returns to set their expectations. However, low yields in the bond market and high valuations in the stock market may be a drag on future performance.

"This isn't your parents' stock and bond market," said Scott Hughes, a certified financial planner in Herndon, Virginia.

Hughes bases his long-term expected returns for bonds on the 10-year Treasury bond yield, currently 1.6 percent. To that, he adds 4 percent to 5 percent in risk premium to the 10-year yield to estimate the future annual returns for U.S. stocks. Under his method, U.S. stocks should have an expected return of 5.6 percent to 6.6 percent annually before inflation.

"We want to be realistic when estimating future asset values and income from assets," Hughes said. "These lower returns still far outpace current cash account yield and inflation."

Even a long-term forecast of 5 percent annually for the U.S. stocks may be too rosy.

Research Affiliates, an investment firm known for its fundamental indexes, projects that the U.S. stock market could gain a 1 percent annualized real return over the next 10 years.