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Cents and Sensibility Guy Steele |
Setting a realistic return
rate for investmentsIF you've been investing for at least a decade, you've already seen a lot of the ups and downs of the financial markets. Now, you may be wondering: "What's next?"
Unfortunately, no one can predict the future. But as long as you make investment decisions based on realistic expectations, you can continue making progress toward your long-term goals -- in all market environments.
Before we look at what it means to maintain a realistic investment outlook in the future, let's see where we've been in the recent past.
AS YOU no doubt recall, 1995 through 1999 were banner years for the stock market. During that time, the S&P 500's annual returns ranged from 19.5 percent to 34 percent (the S&P 500 is an unmanaged index and can not be invested into directly).
From 2000 through 2002, stock prices fell sharply, but in 2003, things turned around, and the major stock market indices showed strong gains.
What's in store for the rest of 2004, 2005 and beyond? No one has a crystal ball, but, as you look ahead, here are a couple of things to consider:
>> Two conditions that helped drive stock prices higher in the 1990s -- low inflation and low interest rates -- are still present.
>> Stock prices may benefit from lower dividend tax rate. Last year, the maximum tax rate on dividends was cut to 15 percent (This expires Dec. 31, 2008). Previously, dividends were taxed at your individual income tax rate. The new, lower dividend tax rate has already induced more companies to pay out more dividends. This, in turn, has helped make dividend-paying stocks more attractive. And, of course, higher demand for stocks often translates into higher stock prices. Stocks are not fixed rate investments and may not distribute dividends. Stocks are subject to market loss, including the potential loss of principal invested.
If these two factors were the only ones influencing the market, you might think the immediate future looks quite bright. However, some other factors may work against a return to 1990s-style returns. For one thing, interest rates have been falling for about 20 years, and they may now have dropped about as far as they will go. Interest payments on debt typically represent one of the biggest costs companies face; during the 1990s, this steadily declining expense helped lead to stronger earnings and impressive returns. If interest rates start creeping up, earnings may suffer.
The 1990s are gone and the stock market returns of the latter part of that decade are not likely to appear again any time soon.
SO, WHAT is a "realistic" rate of return? There's no magic number, but, as a starting point, you might reasonably hope to earn annual returns in the 6 percent to 7 percent range over the next five to 10 years. While there's no guarantee that you will regularly achieve these numbers, they can form the basis for some reasonable planning on your part. And if you plan for 6 percent, but you're fortunate enough to earn 9 percent, you'll be that much closer to achieving your long-term goals, such as college for your kids and a comfortable retirement lifestyle. On the other hand, if you think you'll receive 12 percent, and you "only" get 7 percent, your plans could be jeopardized.
By assuming reasonable rates of return, and by diversifying your investment dollars across a wide array of high-quality stocks, bonds, government securities and other assets, you can help to "smooth out" your investment journey -- and possibly reach your destination sooner than you think.
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Guy Steele is a financial planner and head of the Pali Palms office of Edward Jones. Send planning and investing questions to him at 970 N. Kalaheo Ave., Suite C-210, Kailua, Hawaii, 96734, or call 254-0688