How Will You Invest with Low Stock Market Return? - Retire by 40 (2024)

Nobody knows how the stock market is going to perform in the short term so we shouldn’t worry about it. On the other hand, long term profit is more predictable. Historically, stocks return about 7% per year after adjusting for inflation. Passive investors (index funds) who are in it for the long haul can count on 7% and they don’t have worry about the day to day fluctuation. I’m a long term investor and plan to invest in the market for the next 40 years. However, I’ve been hearing more and more about the expected low return over the next 10 years. I’m in it for the long haul, but 10 years is a long time to live with low return. Would it be smart to adjust our investing strategy until things look better? I’m not sure and I would love to hear your opinions.

Low return

Experts are predicting low single digit return for stock over the next decade. John Bogel, the founder of Vanguard, in particular is a trusted voice and I’m inclined to believe him. Most of our stock investments are in low cost index funds and that is Mr. Bogel’s area of specialty. Here is the formula for calculating return from his book – Common Sense on Mutual Funds.

TOTAL RETURN = DIVIDEND YIELD + EARNINGS GROWTH OVER THE TIME PERIOD + CHANGE IN P/E RATIO OVER THE TIME PERIOD

Here is what John Bogel has to say.

• Dividend yield is 2%.
• Earnings growth has been about 5%, but probably will slow down to 4% in the next 10 years.
• The current P/E ratio is higher than average so it will probably come down to average at some point.

Total Return = 2% + 4% – (1 or 2%) = 4% to 5%

Once we adjust for inflation, the stock market index could return just 1-3% over the next 10 years. I think this prediction is probably accurate for passive index funds, the kind we’re invested in. John Bogel’s prediction may not work for active investors who invest in individual stocks and derivative. Those people depends more on skill (luck?) and not the average market return. Many other experts also expect low return over the next decade and I’ve been hearing it more often.

CAPE

We can see that the Shiller PE ratio is creeping into the dot com territory. Nobody knows what’s going to happen in the next few years, though. The stock market might keep going up and reach the dot com bubble height or it could taper off.

Some scenarios

Let’s say the experts are right and stock will return about 3% over the next 10 years. Let’s look at some scenarios and see what we can expect.

Scenario 1 would be a slow 3% rise over the next 10 years. This would be easy for investors to handle because there will be no volatility. Of course, this is unrealistic. The stock market is volatile and we will see some ups and downs.

Scenario 2 looks like the last 10 years on the stock market. We’d see a bit more growth, a big crash, and then a long recovery. This would be great for young people who has good income and can invest more. However, it would be horrible for people who retire in 2017 and 2018.

Or we could see a lot of ups and downs with a general upward trend. This would be good for working people as long as they can handle the volatility and keep investing.

What can investors do?

The graphs all look different, but the outcome is the same for long term investors. We’d see low profit from the stock market for the next 10 years. 3% is very low especially if you have to sit through a few years of stomach churning drops. Are there some ways to increase our return on investment?

1. Save more

One sure way to increase your total profitis to invest more. Investing $1,000 per month with 3% return will give you about $140,000 after 10 years. However, if we increase the monthly saving from $1,000 to $1,100, then we’d have $154,000 at the end. Saving more is the only guarantee way to boost your total profit.

*This is especially important when you’re early in the investing game. Your saving rate matters a lot more than return. If you save as much as you can, you’ll do well in the long haul.

2. Take on more risk

Investors who are willing to take on more risk might be able to increase their return. The US equity market had done very well over the last 9 years. During that period, the rest of the world has underperformed the US significantly. Experts think this will change in the next decade so now might be a good time to invest in emerging markets and Europe. To US investors, this will sound risky. The US stock market has been doing very well and who’d want to sell and move their money to emerging market? Investors might need to do this to increase their return over the next decade, though.

3. Diversify with real estate

The real estate sector is doing very well again. Home price has been rising all over the country and the interest rate is still low. It is still a good time to invest in real estate in many part of the US. Real estate has a low correlation to stocks and bonds so this is a good diversification. Real estate has a good chance of beating the expected low return from the stock market. Here are some ways to invest in real estate.

• Invest in a rental property. This one can pay off big, but a lot of people don’t want to be a landlord. We own a duplex and a one bedroom apartment. The cash flow has been improving and the appreciation is great too. They aren’t a lot of trouble unless something breaks. Turning over a unit is a lot of work, though.
• Invest in real estate investment trusts, REITs. This is the easy way to invest in real estate. Regular investors can invest in various sectors such as apartment buildings, hotels or hospitals. However, REITs fell along with the S&P 500 index in 2008. They are public companies and can be influence by the stock market.
• Invest in real estate crowdfunding. This is a relatively new way to invest. Investors pool their money and invest in a project they like. I started investing with RealtyShares earlier this year and it has been good so far. There are different types of projects to invest in and they are spread all over the US. I’ve seen strip malls, apartments, single family home, data center, and more. I like RealtyShares because it gives me a way to diversify away from the local real estate market.

*Disclosure: We may receive a referral fee if you sign up for a service through the links on this page.

Our portfolio

Let’s take a quick look at our portfolio. Actually, this is our net worth. It includes our primary residence and other personal properties. They add up to about 5% of this chart so it shouldn’t screw up the percentage too much.

• US stocks – 33%. This is probably a little low compare to most investors. I think it’s about right for this low return environment.
• Bonds – 13%. The bonds yield is right around inflation so the return is even worse than stock. I have bonds in case we have a big stock market crash. We will sell some bonds and buy stock when the time is right.
• International stocks – 14%. International stocks haven’t done well compare to US stocks over the last few years, but that could change in the next decade. If the experts are right, then we’ll get a boost to our profit from this sector.
• Alternatives – 4%. REITs
• Rentals – 24%. Our rentals are worth quite a bit due to appreciation. However, all our properties are in Portland and I need to diversify away from the local area. Portland is booming now, but I seriously doubt it will last. There just aren’t enough good jobs here. That’s why I plan to increase our investment with RealtyShares over the next few years.
• Primary residence – 5%. Also in Portland… At least our primary residence is just 5% of our net worth. That’s a point on my pop quiz – How serious are you about early retirement.
• IP – 4%. Retire by 40 is valued conservatively at 3x our 2016 income.
• Cash – 1%. We’re building up our cash position. It’s tough because I’d rather invest the cash than having it in the bank.
• Others – 1%. Personal property.

I feel okay about our current asset allocation. US stocks is the biggest part of our portfolio, but it’s not huge. It looks like we’re diversified and should do okay over the next decade. The only big problem I see is the big 29% chunk in Portland real estate. We’ll have to work on that.

What about you? Do you have any plan to deal with the expected low return environment? Will you stay the course or make some adjustments?