The idea of stock investments doubling in value every seven years or so is based on an estimated historic average annual total returns of 9% to 10%. If Jack Bogle, founder of the Vanguard Group, is right future returns are much more likely to be in the vicinity of 1% to 2%:
“People ought to be very conscious of the mathematics of investing,” Bogle, who now runs Vanguard’s Bogle Financial Markets Research Center, said in a recent interview. “But they so often ignore it.”
He acknowledges that his 1 percent to 2 percent return calculation isn’t a hard rule, because it’s based on many of the variables affecting market performance. But it’s instructive for understanding why an investor’s net returns pale in comparison to market returns.
Here’s how he figures it. Assume a nominal rate of return for the foreseeable of future of around 7%. Inflation eats two points, taxes, another point, and management fees another two points. That leaves 2%. The Rule of 72 tells us that at that rate it would take roughly 36 years to double your money, a far cry from 7.
What if he’s right? For me that raises a couple of questions. First, does that put a premium on good management or put downwards pressure on management fees? Probably both. In this regard it’s interesting to note that the SEC appears to have come around to the view that if your fund’s performance is significantly better than others’, you’re probably cheating.
I also suspect that professional money managers will receive significantly more scrutiny under a regime of very low returns than they would under one of high returns. Nobody much cares as long as their capital is increasing rapidly. If it’s increasing slowly, not increasing at all, or even decreasing, won’t they be inclined to put everything under a microscope?
Additrionally, wouldn’t expected performance like that put a bit of a damper on the various plans to privatize Social Security? Social Security’s rate of return is in about that range. If you assume that the rate of returns for a fully privatized system are normal and have an average of 2% with a standard deviation of one point my back of the envelope calculation tells me that about three-quarters of the population would see returns below 4% and a quarter would see capital losses.