By Brett Arends
A ‘lost decade’ of low stock returns can be devastating for older investors
What if the Wall Street bulls are wrong?
Retirees face nervous times ahead if Vanguard is right. The investment giant, which is owned by its 50 million investors, warns that U.S. stock-market returns may be ominously low over the next 10 years. And while a “lost decade” of low stock returns may be something that younger investors can take in their stride, as they save for goals decades away, that’s not the same for those who have retired and are living off their investments.
As pointed out by financial analysts – such as Wade Pfau from the American College for Financial Services – what matters for those in retirement isn’t just the average annual return they earn on their investments, but when they earn those returns. Bad returns early in your retirement can be especially devastating, because your income marches on regardless. By the time markets improve, you’ve spent too much of your capital to recover.
And Vanguard’s gloomy forecast comes just as the country goes through “Peak 65,” with more than 11,000 Americans turning that age every day. So record numbers of workers are either retiring, or preparing to retire, at a time when the investment risks are higher than normal.
You can see the problem.
Naturally anyone can make investment forecasts, and if you want to see rosy scenarios you should just talk to any salesman on Wall Street. They will tell you that stocks will earn about 10% a year, regardless of valuations, simply because that’s what they have earned in the past. (A few years ago they were making equally circular arguments about bonds – before the bond bubble burst.)
But what happens if Vanguard is right, or even “directionally” right, and stocks disappoint in the decade ahead? The firm reckons large U.S. stocks will earn average returns between 2.8% and 4.8% a year; the midpoint, naturally, is 3.8%. It predicts bonds will earn between 3.8% and 4.8%, or around 4.3%. And these numbers are “nominal,” meaning they include the illusory gains that come from inflation. Strip out inflation, which Vanguard expects will average between 1.6% and 2.6% a year, and you are looking at very low “real” returns, meaning returns measured in constant dollars. By this math, stocks, at the low end, could end up earning little more than 0% in real terms, and bonds not much more than 1%.
It’s a good moment to remind investors that this happens, and more often than people are apt to remember, especially after an enormous stock-market boom. The U.S. stock market lost you money in real terms – in other words, failed even to keep up with inflation – in one-quarter of all five-year periods going back to the 1920s. Even over longer, 10-year periods, when you’d expect volatility to smooth out, stocks lost you money in real terms 13% of the time and earned dismal returns, of 2% or less, more than a fifth of the time.
And this is before deducting other costs, such as advisory fees, fund management and trading fees, and taxes.
(It should be added that Vanguard reckons your likely returns will be better from small-cap U.S. stocks, U.S. value stocks and international stocks from developed markets, such as Japan and Europe.)
The effect of low returns on the newly retired can be brutal. For example, many retirees try to follow the so-called 4% rule, where they withdraw 4% of their portfolio in their first year on which to live, and then increase the withdrawals in line with inflation every year that follows. If their portfolio earns an average return of, say, 5% a year and inflation is 2%, they could last nearly 50 years before they run out of money – so long as those returns are constant throughout their retirement. But if they start out with a lost decade, when their investment returns barely keep up with inflation, that can cut an astonishing 15 years off the life of the portfolio, even if returns then rebound.
If you have a bear market, where stocks fall sharply early on, the problems can be deeply compounded. In a research paper published earlier this year, Santa Clara University business-school professor emeritus Edward McQuarrie argued that the 4% rule would have outright failed at periods in the last century, and especially for those retiring in the 1960s. He meant that the money would not have lasted for at least 30 years.
Incidentally, these conventional calculations – that retirement portfolios need to last “30 years” with “minimal chance of failure” – are themselves questionable for two other reasons. First, “minimal chance of failure” is of no benefit to someone who is unlucky and runs out of money in their 90s. Most of us want the chance of failure for our retirement portfolio to be as close to 0% as reasonably possible. And second, a 30-year retirement time frame is becoming less relevant. More than a few people retiring at 65 today will live beyond the age of 95. Will the money last 40 years if I need it? How about 50?
I don’t pretend to know what the market is going to do over the next 10 years, beyond the great, unbeatable prediction usually credited to the great J.P. Morgan, Sr. Asked by a journalist what he thought the market would do next, the banker is supposed to have replied gravely that he expected stock prices to fluctuate. I’m willing to hang my hat on that one.
But the risks of poor performance are much higher than most people realize, at least, during a bull market. (In a bear market they often swear off stocks forever.)
In this situation it is worth remembering that retirees also have another option: lifetime annuities from life-insurance companies. These pay you a regular monthly income for life, whether you live for five years or 50. As many financial advisers like to remind me when I write about this, an annuity paying a fixed monthly sum is at serious risk from inflation over the long term. But the initial payouts are way ahead of the 4% rule to compensate. Right now for a 65-year-old they are nearly 8%, meaning someone who buys a $1 million annuity can withdraw $80,000 a year for life.
And you can also buy annuities that increase their payouts every year by a fixed percentage, offering a pretty good buffer against the risks of inflation. (But no, this isn’t perfect either, especially if we get major, double-digit inflation.) Even an annuity that increases payouts by 4% a year will start you off, at age 65, with an initial yield of 5%, or $50,000 in income on a $1 million investment.
There are few certainties. But, as always, there are plenty of risks. And the most dangerous are the ones to which investors aren’t paying close attention.
-Brett Arends
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12-03-25 0800ET
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