The following pages provide important updates of information in the book.
 
(1) Actual updates of capital market forecasts found in Chapter 10 (Updates page 1) as of the dates shown
(2) 2010 update of Figures 2-1, 2-2, and 2-3 in Chapter 2 (Updates page 2)
(3) 2010 update of Figure 2-4 in Chapter 2 (Updates page 3)
(4) 2010 update of Figure 2-5 in Chapter 2 (Updates page 4) 

3/31/09

In chapter 10 of the book, I describe how to establish expected returns for stocks and bonds, because these returns are so critical to the achievement of financial security in retirement.

The long-term expected return for bonds is the current interest rate on long-term US government bonds, which is 5% in the book (page 146). Over the last year, the yield for long-term US government bonds has gone down from 5% to a normal level of, perhaps, 4% since the book was written. Actual current yields are significantly lower than this, but that is because there has been panic buying of US government securities recently. These securities are considered "safe".
 
This buying artificially raises prices and depresses yields (prices and yields move in opposite directions). This is the so-called "flight-to-quality"to which commentators refer.

The long-term expected return for stocks is equal to the current dividend yield plus expected real economic growth plus expected inflation (page 147). In the book, these components are 2%+3%+3%, respectively, for a total of 8%.
 
Because of the decline in the stock market over the last year, the dividend yield has moved up from 2% to 3%. This means that the expected total return on stocks has gone up by that same amount to 9% (3%+3%+3%).
 
What all this means is that total returns will be slightly higher than those estimated in the book in the years before retirement, because this is by definition a period of relatively high stock exposure, and slightly lower in the years after retirement, a period which is characterized by relatively high bond exposure.
 
However, the changes in forecast returns as a result of what has happened in the markets recently do not change the basic structure of the analysis presented in the book or the essential conclusions.
 
The date of this actual forecast is very close to the date of the bottom of the bear market in stocks, and it is thus illustrative of the potential short-term return when the forecast long-term return is in the area of 9%. While this return is lower than the long-term return for stocks, because of the significant decline in the dividend yield from the historical levels, in the modern context, this level represents a major buying opportunity.
 
It is interesting to note that for the subsequent year from the date this forecast was made, the year ended 3/31/10, the return for stocks was 49.7%, and the return for bonds was -14.4%.
 
3/31/10

During the first quarter of 2010, stocks returned 5.4%, and bonds had a negative return of -0.1%. This was the best first quarter for stocks since 1999, and the stock market has now gone up for four consecutive quarters. This was despite a correction in February which amounted to about 8%. As indicated above, it is unusual to have an enormous increase in the stock market from the lows in March, like the one we have experienced without a 10% correction.
 
As a result, it would not be surprising if there is a correction of that amount at some point. However, on the other side, it is important to point out that this enormous increase has taken place without almost any support from individual investors. It appears that they are still so shell-shocked from the 50% decline in the stock market which they experienced that they are unwilling to step up and buy stocks.
 
This is typical behavior for individual investors who come into market rallies only after there has been a significant move and who in the process help make the next peak. It is therefore unlikely that there would be such a peak without participation by individual investors. As these investors gradually come into the stock market, it should continue to overcome any correction and move higher.
 
The yield on the stock market at this point has declined to about 2% from the 3% level of a year ago, because of the sharp gain in the market. It is still likely that inflation will be 3% over the long term and that real growth, which consists of growth in the work force combined with the growth in productivity, will be about 3%.
 
Therefore, using the methodology outlined in Chapter 10 and referenced above, the long-term forecast for the return from the stock market should be 8%, down from 9% a year ago. The yield on the 30-year treasury bond which was used in the book to estimate the future return for fixed income is about 4.75%.
 
These numbers are not materially different than those used in the book, and so the long-term investment strategies recommended in the book are likely to generate the same returns and the same results used in the book.
 
3/31/11

In the two years since the first forecast update of the stock market forecast which was developed in the book, using the same methodolgy as that outlined in the book, the stock market has recovered a significant portion of the decline which bottomed out at that point.
 
The decline in the S&P 500 from the peak in September of 2007 to the low in March of 2009 was about 56%. This Index has now increased by over 90% from the low, as of 3/31/11, but it is still about 15% below the all-time high.
 
This dramatic increase in the Index from the low in a very short period of time is very typical. A significant portion of the long-term return from stocks comes from participating in these recoveries. On the other hand, if you do not participate, because you have sold all your stocks, your long-term return from holding equities would be much less than the returns shown in the book.
 
In the last two years, then, we have had a perfect example of the wisdom of not trying to time your stock market investment. Many people will have bought at the top, as part of the enthusiasm for stocks which created the top, and even more will have sold at the bottom, when they were overcome with fear that they would continue to lose money. This could not be more counter-productive, but unfortunately it is very typical.
 
The experience of the last two years underscores the advice in the book that the best way to invest in stocks is to buy on a regular basis and hold until age and circumstances have changed sufficiently to adopt a strategy of graudal reduction in the exposure to stocks in favor of bonds.
 
The yield on long-term Treasury bonds is currently about 4.5%, although this yield may be somehat lower than it should be because of the Treasury program of buying massive amounts of bonds to provide liquidity for the hoped-for economic recovery.
 
The expected return for stocks, as outlined in the book, is always equal to the sum of the current dividend yield, the expected inflation rate, and expected real growth rate. The current yield is about 2%. Based on the inflation rate implicit in the pricing of Government TIPS (Treasury Inflated Protected Securities), expected long-term inflation rate is about 2.5%.
 
Finally, the long-term expected rate of economic growth is likely to be about 2.5%. This is a reduction from the rate used in the book, because of the current environment of higher taxes, a mountain of regulations which creates hesitation and uncertainty across the entire economy, and the absence of a pro-growth philosophy.
 
The bottom line is that the long-term forecast for the return of stocks is 2.0%+2.5%+2.5% = 7.0%. This is obviously a significant reduction from the forecast of 9% two years ago. This may not seem to be big difference, but consider the following: $1,000 which grows at 9% a year for ten years has a value of $2,367 at the end of the period, while the same $1,000 growing at 7% has a value of only $1,967.

This is 17% less, and the difference only increases as the time period is lengthened.
 
However, even with an expected return of 7%, stocks offer a superior return compared to long-term bonds, although the difference is slightly below the long-term average.
 
However, the important point is that long-term return from a portfolio of bonds and stocks is now lower than it was in the book, because of the lower return from stocks (the book used a return of 8%.) What this means is that people will have to save more over time, either in the 401k account or in the Pay Yourself First account to achieve the standard of living specified in the book. 

3/31/12

The S&P 500 closed at 1325.83.  Since the low in March 2009 of 676.53, a little over three years ago, it has gone up more than 96%. This is clearly an extraordinary increase in a relatively short period of time, but it must be put in context. The low in March, 2009, came after a 57% decline from the high in October, 2007. 

The arithmetic is clear. If something goes down by 50%, it has to increase by 100% just to get back to where it was at the peak. As you can see, this is roughly what happened in the stock market over the last 5 years. In fact, as suggested above, not all the loss from the 2007 high has been recovered. The S&P is still about 15% below the high in 2007.

All this volatility, with dramatic peaks and troughs which no one can predict, supports the view expressed in the book that when you invest in stocks you have to “stay the course” as John Bogle, the founder of Vanguard, says. Imagine what would have happened if you had shared the enthusiasm in the market in 2007 and invested for the first time and then shared the tremendous pessimism in March of 2009 and bailed out. You would have lost over half of your money and never recovered.

 All of this volatility is past history, and the question at this point is what is the outlook for stocks going forward. The methodology identified in the book, which has been used in the above notes, of course, still applies. The formula is that the return for stocks is equal to the starting yield plus growth, where growth is the sum of expected inflation and expected real growth.

 The yield of the S&P 500 is currently 2.0%. Based on the inflation rate implicit in the pricing of Government TIPS (Treasury Inflated Protected Securities), the expected long-term inflation rate is still about 2.5%. Long-term real economic growth is expected to be about 2.5%, which consists of immigration growth of 1% and productivity growth of 1.5%.

The bottom line, then, is that the expected return for stocks is equal to 2.0% + 2.5% + 2.5%, or a total of 7.0%. This is the same expected return as shown above for 3/31/11. Coincidentally, the change in the S&P 500 over the last year is 6.2%. The expected return for stocks of 7% is substantially below the long-term return, which suggests that returns from stocks will be relatively subdued. Investors should not expect out-size returns for stocks from this point, and this is important to keep in mind.

 The situation for bonds is even more concerning. The current yield on long-term Treasury bonds has fallen to 3.3%, which is only modestly better than the expected inflation rate of 2.5% indicated above and which is significantly lower than last year. Interest rates have fallen to such low levels that it woud not be reasonable to expect that they would fall much lower. On the other hand, the odds are better that interest rates will go up, and the resulting decline in prices for bonds will reduce the return from today’s coupons significantly.

However, if you buy and hold long-term Treasury bonds, you will get the coupon return of 3.3%. This return combined with the expected 7% return on stocks outlined above, means that returns on traditional balanced portfolios will be dramatically low. A 50% stocks/50% bonds combination of the two assets would produce a return of only a little over 5%. An 80% stocks/20% bonds combination would produce a little over 6%. 

It is important for investors to recognize that returns from balanced portfolios are likely to be modest going forward, and they should use these returns in their planning for asset accumulation. Depending on the use of balanced portfolios, returns this low may require greater out-of-pocket additions to portfolios than had been expected to achieve the same objectives for retirement planning.