Rooting For a Bear Market?

William Bernstein joined a number of prominent investors by offering a sobering outlook for the future performance prospects on a traditional U.S. stock/bond portfolio: As you take measure of markets, what are the key takeaways right now?

Bill Bernstein: Well, I would say that the expected return of a balanced portfolio is the lowest it’s been in financial history. We’re looking at 3 or 4 percent on stocks, and we’re looking at zero percent on bonds. Those are real inflation-adjusted figures. And when you aggregate those two?

Bernstein: Two percent—I think net of expenses, you’re going to be very lucky to get 2 percent over the next 20 years.

I’m a huge Bernstein fan, but I think making a 20 year forecast of returns is pretty ambitious. There are way too many variables to consider over two decades. But this isn’t some off-the-cuff charlatan making this call. Bernstein is a well-respected, level-headed guy. Making future return projections about the markets is always difficult, but it does make sense to set some loose expectations so you can plan ahead and adjust as reality plays out.

So let’s just look out over the next decade to go over a few different scenarios to consider. Let’s say Bernstein’s return projections are right. I don’t know if he will be but let’s assume he is. If we get on the high end of his range for stocks, investors will earn 4% per year (after inflation).

Anyone that follows the markets realizes that average returns in any given year are anything but average. Almost 50% of annual returns for the S&P 500 are greater than 15%. Over one-third of annual returns are greater than 20%.  And around 14% of years have seen double digit losses. So even if Bernstein’s projections are correct, those returns are not going to come in a consistent manner.

Let’s say we get the bear market many have been forecasting since the start of this bull market. If stocks were to fall 20% in year one, the following nine years would have to see an average of 7.1% annual returns to still end up at the 4% 10 year average.

Now let’s assume there’s a crash in year one and stocks drop 30%. The remainder of the decade would see 8.7% annual returns to reach that 4% decade-long stock market average.

You can see that even with below average returns, there could still be opportunities to profit. Of course, to take advantage you would need cash available to invest at lower prices through either (1) future savings or (2) a liquid allocation in your portfolio that won’t get crushed when stocks do.

If we look at a 60/40 portfolio using Bernstein’s real returns, investors would get 2.4% per year. In this scenario, if there was a bear market in year one this portfolio would see a 12% loss (assuming -20% in stocks and a 0% return on bonds). To get to the 2.4% average return over a decade, the 60/40 portfolio would return 5.3% thereafter.

If there was a 30% stock market crash in year one (18% total portfolio loss), the next nine years would see a 6.8% annual return in the 60/40 to get the overall 10 year performance at the 2.4% average. Even in a lower performing environment there could still be periods that offer higher future returns.

Obviously this entire exercise is conjecture. Markets don’t play out in real life as they do in simulations. However, this does show the importance of continuing to invest when the annual return stream is uneven and especially when stocks are down. With the possibility of lower future market returns, the margin of error will be much narrower.

I have no idea when stocks are going to fall again, but when they do investors have to be ready to take advantage. To benefit from the higher expected returns that tend to follow a market crash or correction requires one very important factor beyond some form of liquidity — the courage to rebalance or buy when stocks are falling and everyone else around you is predicting the end of civilization as we know it.

The current environment means it’s going to be important for investors to reduce the impact of costs and taxes on their portfolio to increase net returns. But even optimizing costs and taxes won’t matter nearly as much as investor behavior. In my view, behavior during bear markets and corrections will be the deciding factor that separates successful investors from the crowd.

Bill Bernstein: Rule No. 1 Is Stick To Your Plan (

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Discussions found on the web
  1. Kyle commented on Mar 12

    I am assuming Bernstien did not include an international allocation. Care to take a guess what a 60/40 would look like with 30% of equities allocated to international?

  2. Steve commented on Mar 13

    Making 20 year projections is useless. Play the lottery. What would be helpful is to use returns without inflation as well. Inflation changes each year.
    Also, we will have another bear market. That’s a fact. Problem is, as you say, some have been saying it since the bull started. Some say it each year, and like a broken clock, they will be right eventually. Then they will promote themselves as having predicted it, and will show you the piece in which they did. But they won’t show you the 10 other bear predictions that didn’t happen as they said. They are the perms bears.

    • Ben commented on Mar 13

      Right, with return projections that long one or two really good years can completely throw off the forecasts. This is why valuation provides context but never a good timing signal. And you’re right that nominal returns could be much better or worse depending on inflation, a huge question mark, as always.

  3. John Thees commented on Mar 13

    What one should do depends on what one’s age is. Recognizing that there are psychological reasons why people do this, probably the best thing a person can do to overcome the fear and inertia is to set up a relatively long term automatic program to get back into the market. I recently suggested such a program to a 75 years old friend of mine who asked me what he should do – he had all of his assets in cash. mostly CDs which were not returning very much.

    I suggested a program where, after setting aside a four years of expenses cash reserve, he should invest a fixed sum every month in a diversified mix of Vanguard mutual funds – 52% Total Stock Market Index, 30% Total International Index, 8% REIT Index, 5% Precious Metals and Mining, and 5% Energy over a period of six years. This is pretty close to one of Scott Burns’ modified couch potato portfolios. I emphasized to him that he needed to do this automatically as much as possible so he would be investing no matter what the market was doing.

    The investment period is relatively long so that it is likely that he will be investing while the market is down part of the time and so that he (and his wife) are not concerned about making one or a few big investments and then losing lots of principal in a big market downturn. The comfort part is really important because it reduces or eliminates the fear that causes the inertia.

    So far they are following my suggestion and are happy with it.

    • Ben commented on Mar 13

      I’m a big fan of automation as well. Take the market component out of the equation as much as possible. Or if we do see a bear market, speed up your contributions if you’d like.

      • John Thees commented on Mar 13

        Completely agree. Follow Buffet’s advice and invest when it feels the worst to do so.

  4. Gregory commented on Mar 13

    My main problem with Mr. Bernstein’s prediction is the dividend. According to him the Market Return= Dividend Yield+ Dividend Growth (Gordon Equation). This suggest that You should buy only high dividend stocks and nothing else for the maximum return. But we know a lot of value stocks and small cap stocks pay NO dividends. Dividend is important but is not exclusive.

  5. Mark Massey commented on Mar 13

    Easy fix to improve this predicted return over next 20 years with a 60/40 portfolio. Go to a 100/0 portfolio. As I have told you before, I have no fixed income…I’m roughly 80/20 and the 20 is cash.

    • Ben commented on Mar 13

      And the thing is that when rates rise you can always move some of that cash into bonds if you so choose. I’ve heard from a number of people that are coming around to the idea of having a cash allocation for spending needs and implementing this type of barbell strategy.

  6. David_Merkel commented on Mar 14

    One thing amiss with most of the comments here, is that it gets easier to predict the market at longer horizons, leaving aside truly destructive scenarios. The market is stock priced to generate 4.7%/yr nominal over the next 10 years, and bonds around 2.5%. Take out inflation, and the 2% is very believable.

    • Ben commented on Mar 14

      I actually have an easier time believing a 30 forecast over a 10 or 20 year one, assuming the end isn’t near a 2008-type event, like you said. I think the Charlie Ellis quote is the short-term is always surprising but the long-term should never be surprising. I wouldn’t be surprised if real returns for a 60/40 are in the 2-4% range.

  7. 10 Monday AM Reads | The Big Picture commented on Mar 16

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  8. Just Financial News / 10 Monday AM Reads commented on Mar 16

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  9. Gen Y Finance Guy commented on Mar 16

    I would not be surprised is this scenario were to play out. But like you said that doesn’t mean there won’t be opportunity to beat the paltry returns.

    You just need to have cash readily available to take advantage of the next correction. We are 6-months into an incredible run, and to me the risk/reward favors the downside.

    So I am holding a larger allocation of cash that I would like, but I am not willing to buy all time highs. At the same time I am paying down my mortgage early in lieu of a bond allocation.

    • Ben commented on Mar 16

      Paying down your mortgage early as a bond substitute is a great idea not many people talk about these days. Especially when you compare mortgage rates (even after accounting for taxes) to bond yields, you’re getting a much better return by paying down the debt. Plus there’s the emotional boost you get from paying off your mortgage which is difficult to quantify.

  10. Market Returns During Ray Dalio's 1937 Scenario - A Wealth of Common SenseA Wealth of Common Sense commented on Mar 19

    […] From the stock market’s peak in March of ’37 to the eventual bottom a year later, stocks fell more than 50%. There was a very difficult 5 year stretch from 1937-1941 that saw stocks fall 36% in total or 8.4% per year. Over the following 5 years stocks were up 120%. These huge gains an losses led to just a 3.58% annual return over the 10 years ended in 1946, showing how even environment of low returns, stocks can still experience plenty of volatility. […]

  11. Matthew Heaney commented on Apr 22

    What you do mean that “there are opportunities to profit”?

    If you’re saving for retirement, then you can simply make a contribution each time you’re paid. And if the market goes way down (e.g. 2008), and your asset allocation is out-of-whack, then sure, sell some bonds to bring you back to your target.

    But what does it mean to “make a profit” because of market volatility? I guess I’m not sure what your goal is. If you’re saving for retirement, there’s nothing special you need to do, except to continue making regular contributions.

    • Ben commented on Apr 22

      The majority of your profits as an investor will come when there’s a market crash because those dollars invested will earn you a higher returns. That’s all I’m saying. And most investors, unfortunately. end up getting scared at the wrong time and pulling back on their contributions until “things get better.”

      I agree with you.

  12. William Felder Accounting | Rates for CPA Services for SMB commented on Jan 12

    […] Rooting For a Bear Market? – A Wealth of Common Sense – William Bernstein joined a number of prominent investors by offering a sobering outlook for the future performance prospects on a traditional U.S. stock/bond portfolio: […]