If they can’t have their cake and eat it too, most investors are at least striving for the highest portfolio returns possible with a minimum amount of risk.
The problem is that the future returns on most major asset classes will be a lot less than their historical averages, at least according to The Vanguard Group’s investment outlook for the next 10 years. Vanguard, the industry leader in low-cost index funds, projects annualized domestic common stock returns in the 6 to 8 percent range, with the international sector returning only slightly more.
On the fixed income side, intermediate-term corporate bonds and bond funds are expected to return about 2 percent a year in the coming decade.
These numbers are a far cry from the historical stock returns of 10 percent and bonds of 5 percent. Now what are you going to do?
Seeking higher returns in this conservative climate is wrought with danger, but that will never stop Wall Street from promoting its latest five-star fund. Remember: A mutual fund’s great track record over the past three years is hardly an indication of what to expect in the future.
In a world of lower returns, it is tempting to forgo an intelligent portfolio strategy in search of something better. It doesn’t make much sense to give up on a smart game plan and gamble on the unknown. That is not the way to build long-term wealth.
In a climate of lower returns, ownership of low-cost index funds assures that you will capture what the market delivers over the next decade and beyond. You should avoid at all costs restlessness with your portfolio’s lower returns, which could lead to volatile trading in search of higher performance.
Want to increase your portfolio returns in an intelligent manner? Instead of switching to the latest fad fund, here are two ways to accomplish this objective in a slower market.
First, reduce your portfolio expenses. If you are paying a mutual fund 1.5 percent to pick stocks for you on top of the 1.25 percent you are paying your investment advisor, fees can eat up a sizable portion of your portfolio’s future returns. A targeted total portfolio with fees of 1 percent or less over time will generate significantly higher returns.
Next, increase your stock-to-bond ratio. No sure thing here, but with rates on fixed income (bond) investments hovering at all-time lows, the returns of common stocks over the next 10 years are almost certain to outpace bonds by a wide margin.
If you are nearing retirement or are retired, however, proceed with caution when increasing your stock allocation. Don’t become so dependent on stocks that you have to sell them in the next bear market to pay your electrical bill. Looking at it another way, allocate enough cash and bonds to cover your expenses over the next five to seven years.
Reduced portfolio returns are inevitable in this investing climate, but that doesn’t mean you can’t still invest successfully. Building a portfolio of low-cost index funds allows you to capture the markets’ returns while focusing on the financial issues that matter most: the saving and spending choices you make in your everyday life.