Why high stock prices are bad for future retirees:
The future will be like the past. Stocks have done well in the past. So they will do well in the future.
Over the past century stocks have returned 7.2% a year, net of inflation. That’s the gain in purchasing power enjoyed by a hypothetical investor starting in 1919, reinvesting all dividends and incurring no taxes or money management costs.One or the other of these numbers might be used in the scientific sounding Monte Carlo simulations from your financial planner. Projecting the past into the future explains the starry-eyed aspirations of the Financial Independence, Retire Early crowd.
In fact, of course, corporate America disburses cash all four ways: dividends, acquisitions, share buybacks and expansion. One factor is that companies can’t maintain their earning power while standing pat. Some of that $7 has to be reinvested to offset the erosion caused by economic and technologic change. This reinvestment is over and above whatever outlays are financed by depreciation allowances already built into the $7 net income calculation.
Now let’s apply this analysis to today’s market. We find that neither 7.2% nor 6.1% is a realistic expectation for stock market returns.
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