The corollary to “What Comes Next?” is “What Happens Years from Now?”
This is not an academic question. Big banks and investment firms typically invest a lot of time and money when trying to figure this out.
JP Morgan Asset Management, for example, compiles a comprehensive set of forecasts each year. More than fifty researchers are tasked with this project, and the report they recently produced runs more than 120 pages
These forecasts are commonly referred to as “Long Term Capital Market Assumptions”. This is a mouthful. It translates to researchers’ best guess on how stocks and bonds will perform over the next ten to fifteen years.
The good news is that updated long-term forecasts for 2023 have improved very significantly compared to a year ago. This holds positive implications for long-term financial planning purposes.
I’ll share with you a snapshot of the changes, then use an example to illustrate why this development is so significant for individuals’ financial plans.
The table below compares long-term return expectations at the start of 2022 with long-term return expectations at the beginning of 2023, based on JP Morgan’s data.
At first glance, the percentage changes for the long-term assumptions might appear to be modest, at 3-ish percentage points for stocks and 2-ish percentage points for bonds.
But seeing how these adjustments play out, and how the higher return assumptions enhance wealth over the long-term, are noteworthy.
Here’s an example.
Say a family has $500,000 to invest in a well-diversified portfolio. They select 60% large company US stocks and 40% US Treasury bonds for their long-term asset allocation and decide to rebalance at the end of each year. They will neither make additional contributions nor take withdrawals during the next 10 years.
Under this framework, how much should they expect to have at the end of the 10-year period?
Using the 2022 return assumptions, they would expect to earn 3.3%, on average, per year. To keep things simple, let’s say they earn 3.3% each year for the next ten years. This translates to $692,000 at year 10—for a cumulative gain of $192,000.
Using the 2023 assumptions, annual return expectations rise by 2.9 percentage points to 6.2%. This higher annual return assumption means their portfolio would grow to $912,000—for a cumulative gain of $412,000.
The 2.9 percentage point difference means the family’s gain is more than twice as much in 10 years’ time.
While an actual financial plan has far more variables that what was presented above, you can see from my example that an upward adjustment in return assumptions (similar to changes JP Morgan has made for 2023) can have a very meaningful impact on total wealth over time.
The Economist magazine summed up the situation well, in a non-statistical way, in the Leaders section of their December 8, 2022 issue:
“This year’s capital losses, however, have a silver lining. If the downside of higher asset prices was lower expected returns, then by symmetry, future real returns have now gone up…
The new regime of higher interest rates and scarcer capital may seem like a shock, but for much of history these were the normal conditions for investors. It was the era of cheap money (that is now behind us) that was weird.”