During their working years, baby boomers have invested a significant portion of their retirement savings in stocks, boosting equity valuations above historical averages for the past 30 years. As the baby boom generation retires and begins spending from their investment portfolios, future equity returns could decrease. With that in mind, it’s crucial that boomers nearing retirement develop retirement income strategies with prudent as well as realistic expectations of future investment returns.

The Role Demographics Will Play

Demographics are one of many factors affecting stock market returns. However, demographics are unique because they are relatively predictable—we have a good idea what the U.S will look like 30 years from now and how future demographics will be different from today.

For example, when baby boomers entered the workforce, there were suddenly more young people earning wages and buying goods and services. Our nation's per-capita GDP grew with their income. As that generation established itself professionally and began to save for retirement, stock and bond returns increased, in kind. In the coming decades, the growing number of people over the age of 65 will translate to fewer Americans putting money into the stock market and more Americans taking money out. As retired baby boomers spend from their accumulated assets, there’s a growing belief among leading economists that stock returns will likely fall below their historical averages.

A Closer Look at U.S. Stock Market Returns

As the chart below indicates, inflation, dividends and earnings growth are expected to contribute less to total returns over the next 10 years than they have over the past 30.

Total Returns of S&P 500 Index

Source: Research Affiliates
¹1The forward estimates are calculated as follows: TIPS are pricing 10-year inflation at 2%. The yield on the S&P 500 is currently 2%. The long-term average earnings growth since 1870 is 1.7%, according to Prof. Robert Shiller, Yale University. Forward P/E ratios are difficult to predict, so we estimate no change in valuation.

Asset Allocation-Setting Appropriate Expectations

The projections above have two major implications. First, it’s important that boomers recalibrate and lower their expectations for future investment returns when developing their retirement plans. The most frequently used asset allocation for boomers - 60% equity / 40% bonds have historically produced relatively high returns over the long run. To count on above average returns moving forward as a crucial and foundational component to the success of your retirement income strategy is a risky proposition to say the least.

Secondly, it will become even more important to regularly review your asset allocation and look for opportunities to improve diversification. For example, if you believe the U.S. stock market returns will be lower than their historical averages over the long term, you may want to consider increasing your exposure to asset classes such as international and emerging market equities.

Bottom Line

The aging U.S. population will create challenges for long-term investors. Over the next 10 years, a portfolio of 60% stocks and 40% bonds is unlikely to replicate the returns that investors have become accustomed to over the past 30 years. 

Of course it’s possible that future returns could be higher than the above forecasts. But to bank your entire future once retired on above average returns is to add a level of high anxiety and stress to your life that makes no sense at all. Better to be prepared for lower returns and plan accordingly if peace of mind is your overarching goal.

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