Since the bottom of the global financial crisis in July 2009, the S&P 500 has generally experienced a bull market. While there were challenging periods in 2018, 1Q 2020, and 2022, stock market investors have largely been well rewarded. However, Goldman Sachs warns that the good times might be coming to an end.
Goldman projects the S&P 500 to return just 3% annually over the next decade—a significant drop from the 13% average annual returns of the past 10 years and the historical 11% since 1930. Their analysis suggests a 72% probability that U.S. Treasuries will outperform the S&P, with a 33% chance the index may even trail inflation through 2034.
As the author of Buy This, Not That, a bestseller that encourages readers to think in terms of probabilities, I found Goldman's perspective intriguing. My key assumption is simple: if you believe there's at least a 70% chance you're making the right decision, you should go ahead with it. This probabilistic approach applies to investing, major life choices, and financial planning, helping to minimize risk while maximizing opportunity.
The people at Goldman Sachs aren't stupid. If they think there's a 72% probability of the S&P 500 returning just 3% annually over the next decade, we should probably pay attention.
Diversify Into Real Estate
If stocks are expected to underperform, consider investing in private real estate through Fundrise. Fundrise invests over $3 billion in Sunbelt real estate where valuations are lower and yields tend to be higher. With the Fed embarking on a multi-year interest rate cut cycle, there should be increased demand in real estate in the coming years.
Why Such An Abysmal Stock Return Forecast?
Goldman Sachs believes the S&P 500 is too heavily concentrated in major tech companies like Apple, Microsoft, Nvidia, and Meta. Historically, when there’s such a high concentration, mean reversion tends to occur, causing performance to suffer.
The S&P 500 is currently trading at around 22 times forward earnings, much higher than the long-term average of around 17 times. If the market reverts to this trend, future returns are likely to be lower.
Goldman isn’t alone in forecasting weak stock returns. Vanguard shares a similar outlook, predicting just 3% to 5% annual returns for U.S. large-cap stocks over the next decade. They also suggest that better opportunities might exist in value stocks, small caps, REITs, and international markets.
On the other hand, J.P. Morgan projects U.S. stocks will return around 7.8% annually over the next 20 years, with bonds yielding about 5%. This would represent a 2.2% decline from the S&P 500's historical 10% compound annual return since 1926.
How To Operate In A Low Stock Return Environment And Still Get Rich
Nobody can predict future stock market returns with certainty. Vanguard issued similar low-return forecasts at the onset of the pandemic, and they have been proven wrong for over four years.
However, as a Financial Samurai who values probabilities over absolutes, let’s consider the scenario where Goldman Sachs is correct. If the S&P 500 only returns 3% annually over the next decade, what strategies can we implement to outperform?
1) Diversify away from the S&P 500 into real estate and bonds
If the S&P 500 is projected to return just 3% annually over the next decade, diversifying into underperforming assets like bonds and real estate could offer better opportunities. Both asset classes have faced headwinds as the Federal Reserve raised interest rates 11 times since 2022.
With bond yields increasing again, these asset classes offer potential value. Furthermore, the significant wealth generated in the stock market since 2009 may prompt a rotation of capital into bonds and real estate as investors seek more stable returns.
If you already own real estate, consider remodeling your rental property to boost rental income. I undertook an extensive remodeling project from 2020-2022 that generates a 12% annual return. Additionally, explore expanding the property's livable square footage. If you can remodel at a cost per square foot lower than the selling price per square foot, you stand to earn a strong return.
If you feel with greater than 70% certainty a 3% average annual stock market return will happen, you could invest your entire portfolio in Treasury bonds. The 10-year is yielding 4.2% and the 30-year is yielding 4.49%. These choices provide a guaranteed income stream, enabling you to withdraw at a rate higher than 3%, while preserving your principal for future generations.
Ultimately, your decision to invest in risk-free Treasury bonds will depend on your confidence in Goldman Sachs’ predictions for the stock market. It will also depend on your appetite for potentially higher returns.
2) Invest in private AI companies given big tech performance
With the S&P 500’s concentration in big tech—largely driven by AI-related growth—it makes sense to consider private AI companies for exposure to future innovation. AI has the potential to solve global labor shortages, drive productivity, and even contribute to breakthroughs in healthcare and other sectors.
Investing in private AI firms through an open-ended venture fund can capture the upside in a sector poised for long-term impact. A reasonable allocation—up to 20% of your investable capital—may ensure you benefit from the next wave of technological advances, especially as AI continues to disrupt industries.
Private companies are staying private longer, allowing more gains to accrue to private investors. Therefore, it is only logical to allocate a greater portion of your capital to private companies.
3) Invest Where You Have Favorable Odds
In 2012, after retiring from my job, I invested my six-figure severance package in the Dow Jones Industrial Average (DJIA) and S&P 500, despite feeling nervous about leaving the workforce.
My Citigroup financial advisor introduced me to structured notes, which are derivative products offering downside protection or upside boosts. One particular note provided 100% downside protection on the DJIA but required me to accept only a 0.5% dividend, compared to the DJIA’s 1.5% dividend yield.
The investment had a five-year duration, and the security of downside protection gave me the courage to invest everything at the time. Given the uncertainty in the market, I wouldn’t have invested my entire severance directly into the DJIA. But with just a 1% annual dividend trade-off for downside protection, I felt confident.
Here is an example of a structured note where you can lose up to 30% of your investment and still get 100% of your principal back. You also get a minimum fixed return amount of 15% + 100% participation on the upside after 15%.
Investing in an Open-Ended Venture Capital Fund
Today, I find favorable odds investing in an open-ended venture capital fund, where I can see its holdings. There’s often a 8-24 month lag between when a private company fundraises and when valuations increase.
By tracking news articles from reliable publications, I can spot signals when a company in the fund is about to raise capital at a much higher valuation. This provides an opportunity to invest at the previous round’s valuation, locking in a paper return once the new valuation is announced.
Take OpenAI as an example. In early October 2024, OpenAI raised $6.6 billion in venture capital, valuing the company at $157 billion—an 80% increase from its February 2024 valuation. During these discussions, you could have invested in an open-ended fund that owns OpenAI to capture the upside, since funds don't revalue its assets until after an event is closed.
If a venture fund had 100% of its portfolio in OpenAI, an investor would be up roughly 60% in just eight months, accounting for dilution. While no fund will have such a concentrated portfolio, you can analyze other holdings in the fund, such as Anthropic, OpenAI’s smaller competitor, and extrapolate their potential future valuations.
The Information recently reported Anthropic is actually looking to raise at a valuation up to $40 billion, or 4X higher. Hence, I’m a buyer in the fund that still has Anthropic on its books at a $10 billion valuation.
4) Work Harder and Longer
Unfortunately, if the S&P 500 is only expected to deliver a 3% to 5% return, you may need to work harder and longer to achieve financial independence. It’s wise to recalculate your net worth targets based on this lower return rate. Project what your financial standing will be in 3, 5, 10, 15, and 20 years and adjust accordingly.
Alternatively, you could still aim to retire at your desired age, as it’s often better to retire early than to chase a higher net worth given time's priceless value. However, this may require adjusting your spending or finding supplemental income sources to maintain your lifestyle.
From my experience since 2012, generating supplemental retirement income can be enjoyable. I’ve driven for Uber, coached high school tennis, provided private tennis lessons, consulted for tech companies, written books, and secured sponsors for Financial Samurai.
When you need more income in retirement, you’ll adapt by reducing expenses and discovering new earning opportunities.
5) Lower Your Safe Withdrawal Rate
In a low-return environment, lower your safe withdrawal rate if you’re retired. If Goldman Sachs and other investment forecasters are correct, this adjustment will increase your chances of not outliving your savings. Conversely, if they turn out to be wrong, you’ll simply have more to donate later.
It’s counterproductive to raise your withdrawal rate while stock market return forecasts decline. A dynamic safe withdrawal rate that adjusts with market conditions is more prudent.
Let's conduct a thought exercise, which I know is not how the 4% Rule was formulated.
The historically recommended 4% withdrawal rate was introduced when the S&P 500 returned ~10% on average, meaning the withdrawal rate represented 40% of that return. Therefore, under similar logic, a safe withdrawal rate of around 1.2% would be more appropriate in a 3% return scenario (40% X 3%).
This may sound extreme, but so does predicting a mere 3% annual return for the next ten years. Let’s take the logic a step further.
If You're Still Working and Planning to Retire
For those not yet retired, consider aiming for a net worth equal to 83 times (inverse of 1.2%) your annual living expenses. For example, if you spend $60,000 a year, your target net worth should be approximately $5 million to avoid the fear of running out of money in retirement.
I understand that an 83X multiple is unreasonable, and most will not reach that goal. However, this figure is only a target if you maintain your current investment strategy, don't lengthen your working years, or don't generate supplemental income after retirement. In addition, the S&P 500's return average could also be higher than 3% on average, enabling you to lower your net worth target too.
If you want to follow the Financial Samurai safe withdrawal rate, then take 80% of the current 10 year bond yield instead. At 4.2%, your safe withdrawal rate would be closer to 3.3%, meaning you would only need to build your net worth equal to 30 times your annual expenses before retiring.
6) Create and invest in your business
Instead of investing in the stock market with the potential for low single-digit returns, consider investing more in your own business or creating one of your own. If you can invest $100 into your business and generate more than $105 in net profits, that’s a better move if you agree with Goldman Sachs' and Vanguard's low stock market forecasts.
The reality is, many private business owners can earn significantly higher returns from their capital expenditures than the stock market. Often, they just don’t realize this because they aren’t comparing the various ways they could be deploying their capital. Or, they're simply too frugal or risk averse.
Personally, I could allocate more funds towards advertising, PR, hiring writers, or developing new products to grow Financial Samurai and boost revenue. However, I do not because I’ve stubbornly focused on what I love since 2009—writing. Once this site starts feeling like a job or business, my interest in running it goes down.
I have peers who spend $500,000 a year on payroll, paying freelance teams to churn out SEO-optimized content to maximize earnings. That's too soul-sucking for me, but it's nice to know I have this option.
A Low Stock Return Environment Will Widen The Gap Between Winners And Losers
I invested through the “lost decade,” when the S&P 500 stagnated from March 2000 until November 2012. However, during that time, savvy investors could have capitalized on buying near the bottom and targeting specific stocks to realize substantial gains.
If we find ourselves in another prolonged period of poor stock market returns, the same principle will likely apply. There will be significant winners and dismal losers. The best stock pickers will have the opportunity to outperform the broader market. Unfortunately, the majority of active investors tend to underperform their respective index benchmarks.
Therefore, you will probably have to count more on your own hard work to get ahead. For me, dialing up the intensity is exactly what I plan to do now that both our kids are in school full-time. I've got until December 31, 2027 to regain our financial independence after blowing it up to buy our current house.
My Current Net Worth Structure
Currently, ~41% of my net worth is in real estate. This asset class offers stability, comfort, and consistent income, along with the shelter it provides. If mortgage rates follow a downward trend, it will create a favorable environment for real estate investments.
About 24% of my net worth is in public equities, with my allocation averaging around 30% since 2012. I’m not rushing to increase my stock investments given the potential for lower returns moving forward. I'm just nibbling with every 0.5% – 1% pullback.
What excites me most right now is investing in private AI companies. My firsthand experience shows how AI has significantly boosted my productivity and impacted job markets. Since I can't get a job in AI, investing in this sector is the next best option.
A forecast of a mere 3% annual return for the stock market over the next decade seems doubtful. However, a repeat of a significant stock market correction, like the one we experienced in 2022, could easily sway more investors to believe in such gloomy predictions.
Having invested since 1995, I've come to accept that anything is possible regarding stock market returns. As a result, keep an open mind and hope for the best, but expect the worst.
What are your thoughts on Vanguard and Goldman Sachs's dismal stock market return forecasts? What percentage chance do you think a 3% average annual return over the next decade will happen? How are you positioning your investments to potentially exceed these low expected returns?
Diversify Into Artificial Intelligence
More gains are accruing to private company investors as these companies remain private longer. As a result, it makes sense to allocate a greater percentage of your capital to private investments. One option to consider is the Fundrise venture capital product, which invests in private growth companies in the following five sectors:
- Artificial Intelligence & Machine Learning
- Modern Data Infrastructure
- Development Operations (DevOps)
- Financial Technology (FinTech)
- Real Estate & Property Technology (PropTech)
In 20 years, I don't want my kids wondering why I didn't invest in AI or work in AI. The investment minimum is also only $10. Most venture capital funds have a $100,000+ minimum. You can see what Fundrise is holding before deciding to invest and how much.
I've invested $143,000 in Fundrise venture so far and Fundrise is a long-time sponsor of Financial Samurai.
If you want to achieve financial freedom sooner, join 60,000+ readers and sign up for my free weekly newsletter. Everything I write is based off firsthand experience because money is too important to be left up to pontification.
Goldman said the market would sputter in 2023. Oops – they were WAY off. Can I interest you in 26.3%? They, like all the players in finance, have brilliant people that are dead wrong all the time.
Mike Wilson, the equity strategies from Morgan Stanley is even worse. But I’m sure they still get paid millions. Best job in the world being a strategist or economist.
12-31-1999 to 3-20-2020
VBTLX
+13.58 |+159.28%
VFIAX
+180.09 |+137.55%
Moving to bonds in late 1999 and again in late 2007 result in saved wealth.
My wife always says a million bucks is real money.
The main GYN problem 2000 to 2015 “My husband lost all our money in the stock market”.
Oh man this hits home since my goal is 10-15 years before retirement. If all goes well, I should get a decent pension for life after government retirement. I probably will need to leave California and retire overseas or to a cheaper state. Selling my home will help pivot to lower cost areas. Hard to say what really to invest in these days.
Your attention for life is more valuable than you might think. Check out my post on how to value a pension.
Possible reductions to stock market returns are one of many evolving risks to funding long retirements and would be a splash of cold water on FIRE. I want to be FIRE, but feel that wet chill of risk, so am a SPARK (Still Part-time And Retired Kinda). I like physical real estate, gold/silver, and bonds as balance to stock market risk and hedges for possible higher-for-longer inflation.
If there’s one thing I’ve learned, it’s to never trust the predictions of the market. Nobody gets it right consistently (including the big names like GS, who has been wrong more times than I can count), and the only way to hedge yourself against unpredictability is to simply remain predictable and steadfast in your investment strategy.
Block out the noise of fear or greed driven predictions. Take a deep breath and stick with your plan. Will it guarantee optimal results at all times? Of course not. And thought experiments like Sam’s are fun to play with and make for good performing content. But in the long term, by being boring, you’ll be better off than those who tried to predict the future. And your mental health will thank you.
I think the “look back” GS analysis of historical data is missing at least one major theme and that is innovation. The next decade in AI could easily be bigger than the internet. The impact AI will have on profits and earnings could be staggering, and it will touch every industry. Every situation has to be evaluated individually, but for my money, limiting stock market exposure because of a report like this will make one very sad when they look back 10 years from now.
I hope so! I’ve got my public and private AI investments ready to go.
Just to whet your appetite, a former peer of mine is now CEO of the Americas for a major healthcare company. I asked her about AI in healthcare and she responded with a recent note she sent her team below:
‘Excellent conversations at hashtag
#HLTHUSA this year. We are on the verge of a major transformation in healthcare, with AI and cloud computing poised to change the industry more profoundly over the next 10 years than in the last 100. AI has the potential to expand access to quality care for all — including the more than 4.5 billion people in the world who aren’t currently covered by essential health services.
A few of many topics I found interesting:
– We face a supply and demand challenge; there are not enough physicians, nurses, and clinicians to meet the demand in the number of patients.
– It is not just about access to care, but TIMELY access to care.
– AI is exciting for clinical decision support, but healthcare systems see huge opportunities in AI for workflow/operations as well.
What are the action items we should take based on the repercussions you think?
Even greater profits for the healthcare companies? United healthcare has been one of my best performers after they gouged me so many times, I decided to buy.
I agree AI will revolutionize every industry in unforeseen ways, unlocking enormous productivity gains whose full impact will take years to unfold.
But it’s doubtful AI will disrupt existing incumbents in the classic Clayton Christensen sense: they’ll just add AI functionality as features to their existing products.
That is, because incumbents control access to users and their data, AI will ultimately be a sustaining, as opposed to disruptive, innovation. Since LLMs are useless without data—and the most valuable data are siloed by aggregators like Amazon, Google, Meta, etc.—the models will become commodified, leaving most of the value to be captured by incumbents.
So while this thesis implies a massive AI-startup bubble, it does lend enormous credence to @Paper Tiger’s thesis of a booming market to come.
Ultimately, this is going to result in more profits for insurers, without reducing costs, and potentially increasing costs for everyone and it won’t result in better care in the ways that matter. So yes, hang on to your UNH lol. Don’t ask me how I know.
I need to firmly disagree with Sam’s analysis, as it fundamentally misunderstands the research and methodology behind the 4% rule (which is based on the Trinity study).
Sam, you said, “Let’s conduct a thought exercise. The historically recommended 4% withdrawal rate was introduced when the S&P 500 returned ~10% on average, meaning the withdrawal rate represented 40% of that return. Therefore, under similar logic, a safe withdrawal rate of around 1.2% would be more appropriate in a 3% return scenario (40% X 3%).”
You reasoned that if 4% is the safe withdrawal rate (SWR) for a long-term 10% average annualized return environment, then a prolonged return period that is just 30% of the average (i.e. 3%) should mean the safe withdrawal rate should therefore be 30% of 4% (i.e. your 1.2%). Dude! No!
This is not at all how the research was conducted or what it means!
Your incorrect assertion that a 10-year period of 3% average annualized returns suggests that 1.2% would be the safe withdrawal rate led you to suggest that people would therefore need 83x their annual spending for retirement (based on dividing 1 by 1.2%). This is dangerously wrong and could needlessly discourage many people from believing retirement is possible.
The 4% rule (suggesting 25x expenses) wasn’t derived by simply dividing average returns by some arbitrary percentage. It came from rigorous historical analysis showing what withdrawal rate would have survived every 30-year period since 1926, including the Great Depression, 1970s stagflation, and every other terrible market scenario.
Telling someone who spends $60,000/year that they need $5 million to retire safely is not supported by any serious research. The historical data suggests roughly $1.5 million (25x expenses) would be sufficient with proper diversification, even through the worst market conditions we’ve ever seen. Scientists who quibble with the Trinity study have found that the absolute LOWEST average annual safe withdrawal rate one would need to survive all but the zombie apocalypse is 3.25%. That means a person who needs $60k a year may, AT MOST, need about $1,850,000. And of course, if social security is factored in at even a fraction of what it is projected to be today, that person would need far less to achieve $60k spending in that low return environment.
Not $5M.
Sam, let’s stick to evidence-based analysis rather than oversimplified math that could needlessly frighten readers about their retirement prospects.
“ The 4% rule (suggesting 25x expenses) wasn’t derived by simply dividing average returns by some arbitrary percentage.”
Of course. I’m just conducting a thought exercise and encouraging people to think dynamically, instead of having a fixed mindset.
Are you a retirement researcher and/or retired as well? If so, I’d love to read your work.
How would you change your withdrawal rate in retirement or target net worth if the SP 500 started averaging only 3%? Finding solutions is what I hope readers can share instead of just disagreeing. Thx
Thanks for your constructive response. I’m not a researcher, just an enthusiast in the space and I read the science on this topic.
In terms of my approach to withdrawals if the s&p500 started returning 3% annually:
First, I wouldn’t lose sleep because a sustained, *long-term* 3% S&P500 return would be unprecedented. Markets have historically reverted to mean returns even after long down periods. So I’d plan for flexibility rather than for disaster.
Given that average annualized returns are made up of lots of up and down years, I’d honestly start with the standard 4% withdrawal based on my initial portfolio value, BUT, I’d then make annual adjustments based on three factors: If my portfolio drops more than 20% from its starting value, I’d reduce withdrawals by 10% that year. So if I withdrew say, $50k in the first year from a $1.25m portfolio and the market tanked 20%, my next withdrawal would be $45k.
Second, I’d skip inflation adjustments in years following negative returns. So, if I withdraw $50k to fund a given year and that year, the market ends down 5%, I’d start my next year by withdrawing the same $50k rather than increasing it by whatever the rate of inflation is.
Third, after an exceptionally good year (20%+ returns), I’d take a “prosperity bonus” of up to 10% extra that year, but only if my portfolio is at least 20% above its initial value *after inflation*. So I’d withdraw $55,000 to fund my next year.
Caveat: I’d keep my base withdrawal rate stable though. Meaning, I wouldn’t be permanently increasing it based on temporary market highs or permanently decreasing it based on temporary market lows. In all positive return years except those exceptionally high return years, I’d stick with a withdrawal of 4% of the initial total, adjusted for inflation.
And the last step is I’d maintain diversification and wouldn’t just be in the S&P.
As my goal in the drawdown period is not to maximize growth but to maintain my desired lifestyle without running out of money, I’d be in a nice boring 60% stocks (low cost index equity funds split between US and international) and 30% bonds, and then a couple other non-correlated assets.
Basically, the S&P may be set for low long-term returns, but a diversified portfolio and a dynamic drawdown strategy has historically preserved portfolios even through extended poor market periods. That way people don’t have to use exotic or high risk investments or engage in extreme over-saving during their accumulation years in order to have a huge net worth to sustain a super low withdrawal rate.
This is, of course, not financial advice. Just my thoughts.
Sounds like you have a plan! Thanks for sharing your thoughts.
“ First, I wouldn’t lose sleep because a sustained, *long-term* 3% S&P500 return would be unprecedented. Markets have historically reverted to mean returns even after long down periods. So I’d plan for flexibility rather than for disaster.”
The S&P 500 went nowhere from 2000 -2012. So there is precedence. How did you invest then?
I truly think that following my dynamic safe withdrawal rate is the way to go.
The person who needs $60K per year but gets a pension and Social Security may not need any retirement investments.
Hi Steve,
Actual history Wife 59 & Me 62 retired September 2015 with $2M & no debt by September 2019 $3M.
Social security Wife at 62, me spousal at 65 and now max at 70.
Now annual payments from pension and social security are $130k.
Last 9 years spent DRIP LTCG to reduce taxes to keep in 15% or 12% bracket. Topped off income with taxable IRA and Roth IRA.
Last 5 years spent Roth IRA to assure enjoyment in early years of retirement.
Titrate MAGI to below IRMMA example 2024 about $206k or not just pay more medicare.
Spending of Savings last 9 years was less than 5%.
Lesson you just can not spend all the savings.
We traveled nine months each year until March 2020. Then in 2021 & 2022 used $170k to heal damage from cancer treatments and for many alternative cancer therapies. All alternatives are not covered by all those insurances. Saving your life is the real reason for savings.
RMD starts at 73 removes 3.65 % of taxable IRA money about $100k / year. RMD at 90 removes 9 % of taxable IRA money about $250 /year. Age 73 to 90 with 5% return on 3M minus required RMDs = 3M taxable IRA at age 90.
“ Saving your life is the real reason for savings.”
Good insight!
My base case is that we are returning to consistent inflation in the 4% range (similar to the 1980’s). Therefore from earnings growth alone we will see greater than 3% nominal returns in the stock market.
4% base case inflation is pretty aggressive. I hope that doesn’t come true. But if it does, then folks need to own real assets that will inflation with inflation.
on october 1 2007 SPY was 154. 10 years later it was 257. that’s a 5.5% annual return, which includes buying at a 5 year high right before the market crash “black swan” event of the great recession. listen to these manipulators at your own peril. These folks want you to think they need your advice (read…their fees) for good returns. if they predict 12% annual returns over the next 10 years, why on earth would you need them? Also, they are notoriously poor market investors, but make most their money on M&A and private investment and public IPOs.
I hope they are sandbagging their predictions as well!
I rarely take much interest in opinions that hide their methodology.
[From my journal:]
Valuation opinions about equities abound.
The latest headline from Goldman Sachs claims the S&P 500’s average nominal return over the next decade will be only 3%. Likewise, Vanguard estimates those returns over the next decade to be about 4.2% (they believe ex-U.S. equities to be 7.9%).
How good is Goldman’s crystal ball? How good is Vanguard’s?
Well, at the beginning of 2024, Goldman stated the S&P 500 would only rise by 5%, but it’s up almost five times that amount year-to-date. As for Vanguard, they have maintained the same 4% to 4.5% prediction for domestic stocks since January 2018. But since 2018, the nominal price return on the S&P 500 has been over 100% (inflation-adjusted it’s 58%). This translates into an 11% annualized return (inflation-adjusted it’s 7%).
Safe to say, neither’s estimates have aged well.
But, most notable to me is Goldman’s statement that “[t]he current high level of equity valuations is a key reason our 10-year forward return forecast sits at the lower end of the historical distribution.” They specifically point to the outperformance of the “Magnificent 7” in the S&P 500.
Goldman is not wrong about the outperformance of the Magnificent 7 over the last few years. Those 7 stocks have fueled the bull market since October 2022 and now make up ~30% of the S&P 500’s market capitalization. Indeed, their performance this year accounts for ~50% of the S&P 500’s nominal returns year-to-date. The same was true in 2023.
The p/e ratio of the “bottom 493,” however, is ~19, which is the S&P 500’s average p/e over the last 60 years (1964 – 2024).
What happens to Goldman’s prediction if you exclude the Magnificent 7? They don’t say, but I don’t see anyone arguing the “bottom 493” are, as a group, “overvalued” or that expectations of continued growth in those companies are unrealistic.
What’s more–excluding Tesla–I think higher valuations of the “Magnificent 6” are justified for the time being. Still, history shows it’s hard to maintain your position at the top, and top stocks tend to underperform the rest of the market going forward.
My last point is that the S&P 500’s average p/e over the past 30 years is 25 (i.e., since the beginning of the internet era in 1994). The S&P 500’s current p/e of ~28 is, therefore, a bit high but not outrageously so—and the forward p/e of the S&P 500, based on analyst earnings estimates, is expected to be ~22.
On that note, I think we’re due for a bull market correction—in the range of 15% (+/- 5%)—but I don’t think it’ll happen this year. Among other things, November through December have a track record of being seasonally good (something like 75% of the time) and, as of yet, I don’t see a catalyst (besides a sudden change in sentiment). I also don’t think the election, whatever the outcome, will cause anything but further buoyancy for stocks as uncertainty lifts (i.e., markets hate uncertainty).
But I do think a meaningful correction in the next calendar year is likely—if not for the market generally, for some of the Magnificent 7 specifically. Nevertheless, I’ll continue to adhere to Bill Gates’ advice to “save like a pessimist, and invest like an optimist,” and to that end, I am more optimistic than Goldman or Vanguard.
What relevance does the average valuation have over the past 30 years? 30 years is the blink of an eye when it comes to equity investing. I wouldn’t go as far as to call it noise, but it is pretty irrelevant compared to 100+ years of history that we have available. It is also an interesting starting point, encompassing the start of the biggest stock bubble we have literally ever seen in this country 1994-2000). We are toward the end of another bubble currently (at least in US stocks, not at all the case in non-US stocks). The earnings component is important to consider and most people ignore that side of the equation. Profit margins are at all time highs right now (higher than 1999, higher than any point in US history). These have never failed to mean revert over time, due to the dynamics of a healthy functional capitalistic economy, as well as a tendency for government intervention when monopolies crop up.
I am glad you asked about the relevance of the past 30 years.
The short answer is technology.
The S&P 500 was created in 1957, but to keep it clean, let’s jump to 1964, which is 60 years ago (I’m politely ignoring your references to 100+ years ago).
What percentage of the S&P 500’s market capitalization was information technology in 1964? The answer is it was in the low single digits.
What was the S&P 500’s p/e ratio from 1964 to 1994 (30 years)? It was 14.
Why is 1994 important? Because it was the start of the Internet era, which changed everything as we know it and created some of the most profitable businesses known to man.
Sure, there was a bubble in the last 90s based on a lot of speculation, but valuations today are not even close to what they were at the peak of the dot-com mania. That said, what percentage of the S&P 500’s market capitalization was information technology at the height of the dot-com mania? The answer is about 20%.
And now? It’s about 40% of the S&P 500’s market capitalization.
My point, therefore, is that you cannot rationally compare the S&P 500 of 1964 to the S&P 500 of 2024, and at least the last 30 years captures the modern market.
What’s more, 30 years is not a “blink of an eye,” it’s a generation.
You can choose to call it “irrelevant,” but I’d respectfully disagree.
The other thing I’d say is the argument about reverting to the mean, at least as far as valuations are concerned, is demonstrably wrong. Do you seriously think we are going to revert to a p/e of 14 again?
Remember, valuation is mostly a subjective application of recency bias. Recent p/e ratios serve as valuation anchors, informing entire markets of what is currently “normal.” So a p/e ratio of 25, which is the average S&P 500 p/e ratio from the last 30 years, is “normal” because that’s what it’s been for three decades.
Put another way, 14 is as arbitrary as 25. There’s no magic to p/e ratios–they are low, high, or just right depending upon what people perceive as “fair value.”
As Benjamin Graham said, “[i]n the short run, the market is a voting machine but in the long run, it is a weighing machine.” For a generation, people have been “weighing” S&P 500 stocks and saying, at least with respect to profitable information technology businesses, the fair value is higher than it is for companies like Boeing (which, coincidently, was the leading stock in the S&P 500 in 1964).
One thing that confused me is your claim that “[p]rofit margins are at all time highs right now (higher than 1999, higher than any point in US history).” If true, that obviously also supports higher valuations, but are you honestly saying you expect profit margins to “revert to the mean”? Is that your argument?
Anyway, it’s safe to say I disagree the entire equity market is in a bubble. As I pointed out, the “bottom 493” stocks in the S&P 500 are trading at the S&P’s average p/e for the last 60 years . . .
A lot of the talk seems to be around the big tech companies comprising such a high percentage of the S&P, and as you say, the bottom 493 aren’t really over-valued at all. What are your thoughts on moving from a regular S&P 500 to an equal-weighted option?
Exactly.
My thoughts are, in sum, “stay the course.”
I don’t believe in trying to realign to time the market. Set it and forget it.
Remember, your plan does not have to be “perfect” to get you across the finish line–i.e., “perfect is the enemy of good.”
Remember in 2008 when Goldman called for $200 a barrel oil and higher for longer? How about all the talking heads like Mike Wilson, “ Morgan Stanley chief economist” saying we’d be in a recession or worse right now. After 3 stellar years he’s bullish now. Watch out below. I love how 90 percent of these “really smart people “ can’t beat the S&P returns over time.
Dollar cost average into the S&P or a similar fund, ignore all the noise, hold as long as you can and you’ll do better than most. There’s more than a 100 years of data to back up this strategy.
Indeed. And Mike Wilson is probably still making over a million a year in being dead wrong. However, as an intellectual who is always curious, I think it’s worth constantly considering different possibilities. Black swan events tend to happen all the time.
You invested from 2000 – 2012. That was a period of tremendous volatility where the S&P 500 was essentially flat. We’ve gone up even more aggressively since.
Your correct, I did invest every week during that time period. The market was down in 2000, 2001 and 2002. I got to buy for 3 years when it was on sale. The only other down year was 2008. Once again on sale. The market may have been flat during that time but my portfolio was up. Buying weekly and reinvesting dividends allowed me to outperform. I love compounding!
my strategy as well! Buy on sales.
Thanks for highlighting the 10-year GS forecast. While it is what it is-just a forecast-that’s intriguing enough for me to sit down and consider lowering my risk profile a bit in my after-tax account. My retirement accounts are pretty conservative and hands off, but my after-tax account allocation has sneaked up to be heavier in stocks than my historical average.
It’s hard to take my foot off the gas when stocks are doing well, but I’d rather pull back some now, shift new contributions into bonds and treasuries, and rebalance on my own terms vs do nothing and cringe when my overallocated stock portfolio gets crushed.
It’s funny, this post is in some ways the mirror image of a post yesterday on White Coat Investor (linked). While I didn’t write it, I mostly agree with it.
Hi Sam,
Thanks for the article. I am a recent 54 yo retiree and I have been thinking about this potential of lower returns for the past year… I think a low return period is likely. I am more aggressively allocated than you: 40% of net worth in real estate, 60% in stocks and bonds, with a 75% stocks, 20% bonds, 5% cash allocation. I think my plan is to move a bit more to bonds, and a bit more to international equities. I am not a fan of REITs or syndications based on prior experience, would love to find more real estate exposure with positive cash flow which is really tough. Frankly, I try and keep it simple with S&P 500 and Total US Stock Market as my primary equities, yet I think the concentration risk is real. Do you have other ideas to lower the risk?
Rob
I just noticed from the Vanguard forecast in the chart is that they predict US REITS to perform the best.
You can always lower risk by shifting away from stocks and more towards treasury bonds and hold them to maturity.
This really makes us think about strategy for the next decade. As someone late 30’s, dual incomes, and our first child due in early 2025, we have aggressively been saving for years.
Total NW just shy of 3m. We have a 2.875% 30 year fixed on our primary which is our long term house, plenty of space for the soon to be 3 of us + our dog. We only owe 740k, it’s worth 2.4ish in So Cal.
We have 500k in my wife’s 401k, 200k in private equity investments, 50k in an after tax brokerage account, 150k in cash, and 3 rental properties that have another 400-450k in equity in total, which cash flow combined about 2k a month positive equity, essentially tax free on paper. (Heartland America rentals)
Only debt is mortgage debt, and one car payment that is paid for by my employer.
All the rentals are on 30 year fixed mortgages between 3-4%. I’ve been debating on selling one or two (capitalize on some of the equity appreciation, insurance costs keep increasing, and maintenance is wearing), to invest more in stocks, and open a 529, have some additional cash around with the baby coming, since my wife wants to eventually open her own consulting business, but this makes me second guess my plan.
Based on your NW articles by age, I feel like we are behind on the after tax investments. What would be your game plan for the next decade? We also both have been working 60-70 hours a week for 16-18 years now and would like to slow down a little bit with the baby coming. We could easily live off my income, or even less, though it’s volatile (Sales related).
I’ve been auto investing $600/week for the last 6 months or so in VOO/SPY/QQQ, and cherry picking some various stocks here or there (Nvidia, some bio tech etc) all in my after tax brokerage account.
Would you keep or sell the rentals? How would you strategize moving forward in our boat?
Hi John – Thanks for sharing and for your questions. I wouldn’t want to give you detailed advice without knowing even more about your goals and risk tolerance. Personally, I like to own rental properties forever, partially due to my kids. I think once your kid comes (congrats), you might get even MORE motivated to work harder and longer. At the same time, kids develop the quickest the first 5 years of life, and you or your wife may want to spend as much time with your child as possible.
I think it’s worth speaking to an Empower professional about your situation and hear what they have to say. Their promo ends October 31, 2024. They can be a good sounding board for you. You’ll get a $100 Visa gift card for free in the mail too, with no obligation to use their services after.
Here’s my experience from speaking to them: How Speaking To A Financial Professional Saved Me From Myself
You can also consult with me, but you’ll have to Google my consulting page if you really want to as there is a queue. Cheers
I’m not Sam but from his post it would seem prudent to hold on to those rentals as stock returns are predicted to be low for the next 10 years and their continued rental income and appreciation may help to make up for the difference and may exceed your stock returns over the next decade. If they are in need of some repairs it would seem to be a good time to repair/upgrade them and try to get even higher rents locked in during this 10 year period. I think if you have a good property management company running them, then this would be advised even more, as it is not eating up a lot of your day to day time or mental fortitude. If you were doing everything yourself, it may be more difficult with a new baby on the way. We have been lucky having an average of 13% returns over the past 10 years, so 3% would be a big hit if it happens.