The Dow Jones Industrial Average index hit yet another high Wednesday — 22,000 points. This follows the S&P 500 and Nasdaq closing at record highs in recent weeks.
As the stock market continues to go on a tear, perhaps you’ve wondered if it’s too much of a good thing. Well, there may be some reason to at least temper your expectations about your future stock market returns.
Investors are in for single-digit — or perhaps even negative — annualized returns from the S&P 500 over the next decade, if a recent report by Goldman Sachs Asset Management is any indication, according to a CNBC report.
Goldman Sachs’ forecast is based on a widely used measurement of the S&P 500’s valuation. It’s called a cyclically adjusted price-to-earnings — or CAPE — ratio, and it’s currently around its highest level in history. CNBC continues:
“The chart shows how the S&P 500’s 10-year-out returns are mostly below 10 percent or negative when CAPE is around historical highs.”
More specifically, the report shows that, when stock valuations have been at their current levels, annualized S&P returns 10 years out have been in the single digits or negative 99 percent of the time. They were negative 17 percent of the time.
Goldman Sachs argues it’s time to consider alternative investment strategies. But among other possible issues with that recommendation, changing your investment strategy every time a new stock market analysis comes out is no way to build a nest egg. In fact, the fees you rack up from all that trading are liable to eat up any returns.
The significance of the current state of the stock market is relative to each individual investor. For example, if you are retiring tomorrow, a stock-heavy portfolio might be too risky, as Fidelity Investments warned baby boomers last year. If you’re a few decades from retirement, though, a stock-heavy portfolio might be best.
Indeed, an analysis by NerdWallet shows that a 25-year-old stands to lose more than $3.3 million in retirement savings by age 65 if he or she doesn’t invest in stocks.
The analysis was based on 40 years of stock market returns and interest rates. It looked at three investment scenarios for a 25-year-old who earns the median annual income for that age ($40,456) and saves 15 percent:
- Investing entirely in stocks
- Saving entirely in standard savings accounts
- Saving entirely in cash
NerdWallet found that, despite periods of stock market volatility, the hypothetical millennial would end up with $4.57 million after 40 years of investing entirely in stocks. That’s before adjusting for inflation and after accounting for annual investment fees of 0.7 percent.
By comparison, the 25-year-old would end up with $1.27 million after 40 years of investing entirely in interest-bearing savings accounts. (Saving entirely in cash creates no gain at all, leaving the saver with $563,436.)
“That puts the potential cost of keeping money in a savings account rather than investing in the stock market at over $3.3 million during a 40-year time horizon. The opportunity cost of leaving a sum that large on the table could be a bigger risk to millennials than stock market volatility.”
This is why Money Talks News founder Stacy Johnson’s rule of thumb for how much of your portfolio should be in stocks is based on your age.
He explains in “Ask Stacy: How Do I Invest in the Stock Market?“:
“Start by subtracting your age from 100, then put no more than the resulting percentage of your long-term savings into stocks. So if you’re 25, 100 minus 25 equals 75 percent in stocks. If you’re 75, you’d only use stocks for 25 percent of your savings.”
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