Great Expectations – How to estimate future stock and bond returns when creating a financial plan (2019)

Determining an appropriate asset allocation is one of the most important decisions an investor will ever make. This decision is based on the investor’s ability, willingness and need to take risk. It considers personal factors that will vary among individuals—such as time horizon and comfort level with the ups and downs of the market—but it also requires assumptions about the future returns and volatility of the major asset classes. Consider an investor who is 20 years from retirement and requires a long-term rate of return of 5% for her portfolio to sustain her to age 90. What mix of stocks and bonds might provide that level of growth? And since returns vary from year to year, how bumpy a ride should she expect along the way?

A financial planner cannot answer these questions without making assumptions about rates of return and volatility. These assumptions don’t need to be precise, but they must be reasonable. In this paper, we describe the methodology we use to calculate the expected returns and risk level of stocks and bonds, and how we use these assumptions in our clients’ financial plans.

This report was written by Raymond Kerzérho and Dan Bortolotti. The ideas, opinions, and recommendations contained in this document are those of the authors and do not necessarily represent the views of PWL Capital Inc.