Outsized return expectations

An FS Investments study found that investors expect an average market return of 7.0% over the next five years.1 But as market dynamics have changed, a traditional 60/40 portfolio is unlikely to deliver the same level of returns that investors enjoyed over the past few decades.

annual total return expected by investors over the next five years1

What got us here won’t get us there

A closer look at the environment driving fixed income and equity returns can help us better understand what it would take to generate a total return of 7% or more going forward.

Low interest rates

Interest rates have gradually declined since the 1980s, but the pace accelerated after the financial crisis. In a low yield environment in which a balanced fixed income portfolio generates annual returns of 3%–4%,2 the equity portion would need to generate returns of approximately 9% in order to achieve a 7% total portfolio return.

Learn more: Where could interest rates go from here?

High stock valuations

Periods of high equity valuations have historically been followed by relatively low future returns, with the inverse true for periods of low equity valuations. Assuming equity market returns over the next 10 years are similar to the historical average of around 5% per year when starting with valuations at current levels,3 a fixed income portfolio would need to generate returns of 9%-10% per year to achieve a 7% total portfolio return.

Learn more: Take a closer look at P/E ratios and expected future returns.

1 FS Investments survey administered through Google Surveys to a random sampling of 515 investors between March 25, 2019 and March 27, 2019. Respondents indicated they had $100,000 or more of invested assets.

2 Bloomberg Barclays U.S. Aggregate Total Return Index yield-to-worst as of December 31, 2018.

3 Macrobond and FS Investments. S&P 500 Index from January 1, 1950 to December 31, 2018.