“Will I ever get it back?!”

The dramatic plunge in equity investment values across asset classes that began in mid-2008 and continued through much of the first quarter of 2009 has had a devastating effect on investment portfolios. During the last client conference call that Aspiriant hosted on February 27th, we addressed questions about near term prospects for the market and the economy. During that call, Jason Thomas, Aspiriant’s Chief Investment Officer, also made a brief mention of the dimensions of market performance that would be required in order to achieve the same wealth goals expressed by our clients prior to the precipitous declines. It is difficult to avert our immediate attention from the volatility, fear, and glimmers of hope that characterize our current market and economy. Still, as our clients’ portfolios are built to endure for the long term, we believe a deeper discussion of the impact of a range of recovery scenarios is important for developing confident and actionable expectations about the future.

Assume a portfolio that was initially worth $100 and was expected to grow 6.5% annually, on a pre-tax, pre-inflation basis, for 20 years. It would be worth $352 at the end of those 20 years. [The 6.5% represents Aspiriant’s estimate of the 30th percentile return (i.e. a client has a 70% probability of achieving such a return or better but still a 30% chance of falling short) and is approximately equivalent to a 5.0% after tax return]. However, if the portfolio were to sustain a 45% decline in value in the first year and then would continue to grow 6.5% annually for 20 years, the portfolio would then be worth only $194 dollars at the end of the timeframe in pre-tax dollars. After sustaining the initial decline, in order for the portfolio to achieve the same initially expected value of $352 at the end of the 20 years, the portfolio would now have to grow at a 9.7% annual rate.

We recognize that although portfolios are constructed with a long-term perspective, the specific time frames for reaching one’s unique goals, of course, will differ from client to client. Further, the declines sustained by individual portfolios range as well depending on asset allocation. The following chart describes the rate of return that would be required to achieve an original goal of a 6.5% annual pre-tax return assuming different levels of initial decline (as indicated in the far left column) and different return horizons (as indicated across the top row).

How reasonable is it to expect that a well-diversified portfolio might return an average of 9.7% or better over the next 20 years? The chart below show the maximum, median, and minimum value of 1, 5, 10, 15, and 20-year rolling returns for small capitalization domestic stocks, the S&P 500, long term Treasury bonds, and short term Treasury bills calculated monthly beginning in 1950 through the end of 2008.

For example, the median 20-year rolling return for the S&P 500 over the past nearly sixty years of data has been 11.4%, with a minimum 20-year return of 6.4% and the maximum of 18.3%.

Over the same nearly sixty-year total period, the median 90-day Treasury bill return for rolling 20-year periods has been 6.2%. This reflects a much higher average interest rate environment than we are currently experiencing. Nevertheless, just as 90-day Treasury bill rates increased from .8% in mid-2003 to 4.9% in mid-2007, we expect that, over the long term, interest rates will increase.

So, some combination of just these two simple portfolio components (large cap domestic stocks and bonds) should be able to achieve a complete recovery to target values...if your time perspective for your objectives and your patience can hold for twenty years or more. A more aggressive asset allocation could recover even sooner; and we believe our efforts to build optimal asset allocations, identify effective implementation vehicles, and manage expenses and costs will maximize the potential to recover values…and then some. But, if your actual time frame is much shorter, then a full recovery remains at significant risk.

Lauren Pressman
Director - Investment Research

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