Over my 12-year career in finance, I have seen many people grapple with assumptions for rates of return. If you are planning your financial future, it’s crucial that have good assumptions to help you predict if you will have enough money to accomplish your financial goals. As a director at JPMorgan, I have become intimately familiar with the various different ways people, professionals, and institutions think about these assumptions. You might be surprised that even some notable financial planners and asset managers are just making up a number or just putting a round random number for every single asset (assuming 6% for cash AND stocks). Many of the larger asset managers have a complex method for projecting future returns, which I will talk about in a moment. The problem with that is they often use this as the only assumption for the entire length of the financial plan, when it is really meant to be only a 10-15 year forward looking projection. If you have a 20+ year horizon, then it might not work. I will discuss a method we use today to provide reasonable long-term average for your financial plan.
With most financial plans, you want to at least achieve about a 4% rate of growth, however many people shoot for 7% or more. What rate of return makes sense for you, heavily depends on your appetite for risk. If you only save in cash your whole life, you might only expect 1-2% returns, but maybe around 7-12% annualized returns if you’re diligently investing heavily in stocks. At Nudge, we hire independent economists every year to ensure that we give you accurate numbers and an unbiased approach to think about rate of return.
There are two main schools of thought for coming up with your rate of return assumptions: Historical and Future Projected. Let’s examine the S&P 500 (SPX) for this conversation.
The most common method is looking historically at the stock market (SPX) over the past 10, 20, 30, or more years to see what the returns have been. While this is a very helpful gauge of how stock have performed, many people would argue that this is not the best gauge of how stocks will perform moving forward. Financial advisors are even trained to say, “past performance is not indicative of future results.” Nonetheless, if your time horizon is long, and you are diligent with keeping your money invested in stocks through tough times, then investing in stocks is often a wise decision. Between 1950 and 2022, the stock market produced 11.1% average annual returns. However, if you look at every single 20-year rolling period during that time, the annual returns varied widely between 6% to 17%. This goes to show that the next 20 years could produce a number of different outcomes. Is it the 10-ish percent that many people tend to assume, or will it be closer to 6% or 17%? Do you want to assume that it will be on the lower end, then hope for better returns?
Future Projected Method
The second method is using complex methods of coming up with assumptions for what the market will perform over the next decade or two. Because this requires a lot of research and educated guessing, you tend to find large asset management institutions conducting this type of study, such as Blackrock, Citi, Wells Fargo, etc. Hold your eyelids open for a moment, because I’m going to nerd-out on you real quickly… These institutions will look at the historical volatility, interest rate, and geopolitical environment, and assess the current makeup of those dynamics to come up with future expectations. Okay, nerd moment over. I’ve read the 150-page assumption study from one of these institutions in the past and WOW was it boring. However, it made a lot of sense and was comforting to understand how we can use solid economic measurements to possibly tell the future of the markets. I had the privilege of working very close with some of the people that were on these teams, and it was commonly understood that these assumptions were time-tested and trusted by top executives to guide public companies. So is NUDGE going to staff ourselves with an army of economists and financial analysts to give you our own projections? Heck no. Let’s just see what the big guys think…
Reputable Forward Looking Assumptions
Here are the assumptions for stock returns (SPX) over the next decade.
Top 5 Global Institution #1: 7.5%
Top 10 Global Institution #2: 7.2%
Top 20 Global Institution #3: 7.9%
What About Volatility?
You won’t really have good projections unless you have a good assumption for volatility. A portfolio with a return of 10% and a volatility of 5% (low) will have a very different outcome than a portfolio with a return of 10% and a volatility of 20% (high). You will find a detailed breakdown of historic, future projected, and the NUDGE blended assumption of volatility numbers in your asset allocation module.
While we want to keep this conversation simple by discussing stocks, there are many types of assets for which we can try to project returns and volatility. We could spend time trying to figure out assumptions for small cap tech stocks, but it probably won’t do anyone much good for their financial plan. However, it is helpful to at least include some assumptions for bonds, because that is an integral component to portfolios to reduce volatility as you get older.
Which method is best for you? At NUDGE, we use a blend of historical and future projected returns and volatility and we update them every year. If you want the easy route, just leave your NUDGE profile on the default mode and you’ll be all set! For 2023, our baseline assumption is 12.2% return for stocks with a 16.91% volatility, and 2.65% return for bonds with a 5.48% volatility. However, inside your profile, you can choose from our blend, historic, or future projected assumptions from top institutions, or customize your own. We’ll give you the tools to make a choice that you feel good about!
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