Analysis of the contribution of dividends, earnings growth and valuation to past returns raises some red flags regarding the next 10 years. Near-all-time-low dividends are providing less protection than dividends have historically provided for investors. In addition, after two decades of steadily increasing p/e ratios, the chances of valuation making a negative contribution to returns appear to be increasing.
Does your retirement plan assume that you will earn average returns on your investments? If so, your plan may be at risk. This post explains why. It is certainly possible that you will earn average returns. However, that is only one of the possible outcomes -- many of which are significantly worse than average. Unless you have an understanding of the variability of stock market returns, you will likely overestimate the likelihood that your retirement plan will work.
In this post, I am again taking the viewpoint of an investor planning for retirement. We'll assume the same situation we assumed in Don't Plan Retirement Assuming Average Stock Market Returns. That is, we have a 45 year old who wants to retire at age 65. He has received a $100,000 inheritance, and wants to accumulate $670,000 in the 20 years remaining before he retires. It turns out if he receives the average 20-year percentage return in my Dow history database, his ending portfolio will be about $670,000. Do you think if he invests the $100,000 in the stock market at age 45 then all of his retirement planning problems are solved? Think again.
How Much Will Your Stock Investment Grow? What Will $100,000 be Worth Invested in the Stock Market for 20 Years?
(Note: if you want to know what $100,000 will be worth invested at a fixed rate of return (e.g., in Treasury Notes/Bonds or a CD), or NOT invested, see footnote.)
The Variability & Distribution of 20-Year Stock Market Results
In Range of Stock Market Returns in Dollars, we looked at the increasing gap between the best and worst outcomes as the holding period went from 10 to 100 years. From the high-low bars in that chart, we saw that
Above is a very long-term chart of the DJIA (Dow Jones Industrial Average), including the 25-year moving average (click chart to expand); it uses this past month's close for this year's close. It shows that the market rarely falls very far below its 25-year moving average.
September, Year-To-Date & Recovery-To-Date Review
Note: click here for October data
In early March 2009, I posted Dow At 25-Year Moving Average. The Dow continued lower for several more days before bottoming at 6547 on March 9 --