A Dire Warning For Buy-And-Hold Investors…

We’re barely a month into 2019, but the 2020 election season is already in full swing. 

Personally, I don’t have any opinion on the candidates who have thrown their hat into the ring (other than that I’m not sure we need politicians running for president almost two years before the election, but that seems to be the current system). 

Over the next two years, many political commentaries will focus on whether we can afford the programs candidates propose. Some will argue that deficits are already too high and adding trillions in spending will push them even higher. 

Once upon a time, governments were expected to balance their budgets, but then economist John Maynard Keynes realized that governments could stimulate growth by running deficits when the economy contracted. Keynes also suggested running a surplus to offset the deficits when the economy was expanding, but politicians seem to have forgotten about that part of his work. If they followed that advice, deficits would rise and fall, and, in the long run, the government’s budget would be balanced (in theory). 

That theory illustrates the concept of mean reversion, where a value fluctuates above and below its average. Mean reversion has also been applied to the stock market, and practitioners of this idea are warning that investors face problems in the long run.  

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Low Returns Going Forward?
One example is the work of Research Affiliates, a research-driven asset management firm that reportedly has $170 billion in assets under management. 

Research Affiliates publishes a great deal of its research, including a model based on mean reversion that shows the expected long-term returns of asset classes. In the long run, the stock market is expected to deliver average returns. There will be periods when returns are above average, and those periods will be followed by times when the market delivers below-average performance. 

Right now, mean reversion models are pointing to low returns for stocks in the next few years. I’ve reprinted the results from Research Affiliates’ mean reversion model below, which illustrates the expected returns for various asset classes. As you can see, the asset manager expects U.S. stocks to deliver average returns of less than 4% a year over the next 10 years. 

expected returns chart

Source: Research Affiliates 

And Research Affiliates isn’t alone in its underwhelming estimates. A number of other firms produce similar asset class forecasts, and many have suggested that investors will face lower than average returns. GMO, another large asset manager, expects an average annual loss of about 2.5% over the next seven years for large-cap stocks. The firm expects small caps should do better, with an average annualized gain of about 1.3%. 

#-ad_banner-#GMO expects value stocks in emerging markets to be the best-performing asset class, potentially delivering an average annual return of about 8.2%. Research Affiliates sees potential returns of about 10% a year in emerging markets. 

This all indicates that investors should not expect a buy-and-hold strategy to deliver acceptable returns in the long run. 

This should be pretty concerning for the average investor. After all, if you were counting on returns of 7% per year (or more), then what are you going to do to make up the difference?

Allow me to make a suggestion…

It’s Time To Try Something Different
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