The illustration shows that 10-year annualized returns for a 60% stock/40% bond portfolio over the last decade largely fell within our set of expectations, as informed by the VCMM. Returns for U.S. equities surpassed our expectations, while returns for ex-U.S. equities were lower than we had expected.
The data reinforce our belief in balance and diversification, as discussed in Vanguard’s Principles for Investing Success. We believe that investors should hold a mix of stocks and bonds appropriate for their goals and should diversify these assets broadly, including globally.
You may notice that our long-run forecasts for a diversified 60/40 portfolio haven’t been constant over the last decade, nor have the 60/40 market returns. Both rose toward the end of the decade, or 10 years after markets reached their depths as the global financial crisis was unfolding. Our framework recognized that although economic and financial conditions were poor during the crisis, future returns could be stronger than average. In that sense, our forecasts were appropriate in putting aside the trying emotional strains of the period and focusing on what was reasonable to expect.
Our outlook then was one of cautious optimism, a forecast that proved fairly accurate. Today, financial conditions are quite loose—some might even say exuberant. Our framework forecasts softer returns based on today’s ultralow interest rates and elevated U.S. stock market valuations. That can have important implications for how much we save and what we expect to earn on our investments.
Why today’s valuation expansion limits future U.S. equity returns
Valuation expansion has accounted for much of U.S. equities’ greater-than-expected returns over a decade characterized by low growth and low interest rates. That is, investors have been willing, especially in the last few years, to buy a future dollar of U.S. company earnings at higher prices than they’d pay for those of ex-U.S. companies.
Just as low valuations during the global financial crisis supported U.S. equities’ solid gains through the decade that followed, today’s high valuations suggest a far more difficult climb in the decade ahead. The big gains of recent years make similar gains tomorrow that much harder to come by unless fundamentals also change. U.S. companies will need to realize rich earnings in the years ahead for recent investor optimism to be similarly rewarded.
More likely, according to our VCMM forecast, stocks in companies outside the United States will strongly outpace U.S. equities—in the neighborhood of 3 percentage points a year—over the next decade.
We encourage investors to look beyond the median, to a broader set between the 25th and 75th percentiles of potential outcomes produced by our model. At the lower end of that scale, annualized U.S. equity returns would be minuscule compared with the lofty double-digit annual returns of recent years.
What to expect in the decade ahead
This brings me back to the value of forecasting: Our forecasts today tell us that investors shouldn’t expect the next decade to look like the last, and they’ll need to plan strategically to overcome a low-return environment. Knowing this, they may plan to save more, reduce expenses, delay goals (perhaps including retirement), and take on some active risk where appropriate.
And they may be wise to recall something else Jack Bogle said: “Through all history, investments have been subject to a sort of Law of Gravity: What goes up must go down, and, oddly enough, what goes down must go up.”2
