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What Assumed Rate of Return is in YOUR Financial Plan?

In the January 20, 2018 weekend edition of the Wall Street Journal, Jason Zweig writes an excellent article titled “The Fantasy is Alive, Just Don’t Embrace It.” The article urges investors to be brutally honest about future returns in their portfolio. He illustrates the unrealistic expectations of the investment community by using the most sophisticated (and presumably, most knowledgeable) of all investors – managers of public pension plans, as an example.

A recent study by Alexander Andonov and Joshua Rauh looked at the expected returns of more than 230 public pensions representing more than $2.8 trillion in combined assets. They found the average expected returns these presumably expert investors assumed over the long term was 7.6%. That is 4.8% after their assumed inflation rate of 2.8%. Here are the assumed asset class returns: Cash 3.2%, Bonds 4.9%, Real Assets 7.7%, Hedge Funds 6.9%, Publicly Traded Stocks 8.7% and Private Equity 10.3%.

If you take a hard look at the current conditions for each of those asset classes, you will find those assumed returns to be quite aggressive. Take for example, cash. The assumed return of 3.2% is over double the amount of the highest-returning institutional money-market fund (currently yielding 1.5%). Bond returns are the same story and the only way to come close to achieving those assumed returns is to take on more risk – junk bonds anyone? The assumed returns on stocks look reasonable in light of the long-term averages until you remember those long term averages were achieved during generally lower valuations. So, I have a few questions for you:

  • Do you have a financial plan?
  • If so, what is the assumed rate of return in that plan? Is it reasonable considering today’s market and economic conditions?
  • Does your investment portfolio have exposure to Real Assets, Hedge Funds, and Private equity?

If the answer to any of these questions is “no,” give us a call. We would be glad to give you a no-cost consultation.

Jimmy Patton

January 21, 2018

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