Is the surging stock market due for a slowdown? At least one financial services firm thinks so, warning that investors should prepare for a shifting landscape marked by lower returns and elevated risks.
As part of its 2022 U.S. Retirement Market Outlook, T. Rowe Price notes that retirement savers should anticipate investment returns being lower in the midterm than in recent years. With the tailwinds that have buoyed global economies during the pandemic recovery likely to fade, those who are saving for retirement can take several steps to weather the potential drop-off in investment returns, including adding more growth-oriented assets to their portfolios, according to the T. Rowe Price report.
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Why Investors Can Expect Lower Returns
Despite the economic turmoil wrought by the COVID-19 pandemic, the stock market has surged to new heights since a mass sell-off in March 2020. The S&P 500, Dow Jones Industrial Average and Nasdaq Composite have climbed to all-time highs in 2021 amid vaccine distributions and increased economic activity.
The stock market’s recent run comes on the heels of the longest bull market in history, which spanned from 2009 to 2020. Since 2009, the S&P 500 has only posted one losing year for total returns (2018). In fact, the index has posted total annual returns of more than 15% in seven of those 12 years. The index, which tracks the performance of 500 large public companies, is up more than 25% in 2021.
But T. Rowe Price predicts less robust returns in the future.
“We believe midterm returns will be lower than those seen in previous periods—in some cases considerably lower. This has significant ramifications for retirement plans and whom they benefit,” the firm states in its report.
The financial services firm first points to fixed-income markets and the near-historic low interest rates. With rates and yields expected to rise, T. Rowe Price says the total returns for many types of bonds may be negatively impacted.
As for the equity markets, elevated valuations may offset the “positive outlook for earnings growth,” the firm wrote.
“As a result, we expect returns in many large markets such as the U.S. to be restrained relative to recent history,” it added. “While valuations across asset classes vary, and some assets are attractively valued, the valuations of most assets are elevated on these measures.”
Lastly, T. Rowe Price points to several risks that markets face, including inflation. While fiscal stimulus, earnings growth and economic activity have all helped propel the pandemic recovery, inflationary fears persist. In October, the Consumer Price Index for All Urban Consumers rose 6.2% compared to 12 months earlier, the largest increase since 1990.
The risks extend beyond U.S. markets. T. Rowe Price notes that China is facing supply chain disruptions and rising commodities prices. Elsewhere, virus mutations and vaccine rollout challenges may also hamper investment returns.
“While the global economy has been buoyed by a period of extreme liquidity driven by fiscal and monetary stimulus, these tailwinds are likely to fade as central banks begin to pursue more moderate policies,” the report states. “Although these conditions may not materialize as significant headwinds for growth, we believe they contribute to a less compelling risk/reward profile going forward. Retirement investors will need to be positioned accordingly.”
How Retirement Savers Can Respond
Investors who are saving for retirement have three options for meeting the challenge of lower than expected future returns:
Save more or delay retirement: T. Rowe Price acknowledges this may be the “least attractive” option, however saving more or simply delaying retirement can help offset lower returns. By delaying retirement, a person can reduce the number of years for which they’ll need retirement income. Postponing retirement and working longer can also enable a person to claim Social Security later. Delaying Social Security beyond full retirement age will result in a larger benefit.
Acquire more growth-seeking assets: The second option may mean increasing a portfolio’s equity composition or introducing fixed-income securities that offer higher returns. This can lead to more risk, but a target date fund with a growth-oriented glide path may be a good option for doing so, especially for investors whose retirements are still years away, T. Rowe Price said.
Limit spending in retirement: The third and final option is to limit spending in retirement. “T. Rowe Price analysis of retirees’ spending habits reveals that retirees tend to adjust their spending to their income,” the report states. “Most of the retirees who do adjust their spending have the means and flexibility to do so. The poorest households, however, cannot spend less.”
Bottom Line
As the U.S. and world economies continue to wade through the COVID-19 recovery, T. Rowe Price warns that investors should expect lower returns in the midterm compared to recent years. The financial services firm says it bases this assumption on bond yields that are expected to rise, devaluing current bonds; equity valuations that are higher than they should be; as well as economic risks that include inflation and various geopolitical challenges.
To limit the impact of lower investment returns, those planning for retirement can simply save more or delay retirement. They can also add more growth-seeking assets to their portfolios, or adjust their spending habits in retirement.
Retirement Planning Tips
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Source: finance.yahoo.com