Is it time to revisit 2 key portfolio assumptions?


By David Joy, Chief Market Strategist, Ameriprise Financial

Key Points

  • It’s important to regularly review the investment assumptions in your portfolio.
  • Future rates of return and the long-term inflation rate are two key assumptions.
  • At your next appointment with your Ameriprise advisor, consider taking a few minutes to revisit them.

Most healthcare providers recommend that patients proactively talk with their physicians and ask questions about their health, rather than passively accept what they are told.

The same advice can apply to one’s financial health. While clients might speak with their financial advisors more frequently than with their physicians, at least one of their financial check-ups should include a proactive review of the investment assumptions upon which their portfolios are built.

Establish expectations for long-term returns

The expected future rate of return is one investment assumption to consider reviewing because we believe it is reasonable to expect investment returns in the future may be lower than those in the past.

Demographics show that populations are aging and growing more slowly. This may lead to slower economic growth and, consequently, lower corporate earnings growth. Additionally, interest rates have fallen to historic lows. And the forces of globalization, which have contributed to economic growth, now appear to be reversing through tariffs as well as nationalism, for example.   

Over the 10-year period that ended with the third quarter of 2019, a simple blended portfolio comprising the S&P 500® Index and the Bloomberg Barclays U.S. Bond Aggregate delivered an average annual return of 8.5%. Anyone assuming a future rate of return that high may be in for a rude awakening. But even being more conservative, it is easy to see how important it is to not overestimate future returns.

For example, let’s say that to be financially conservative you establish a 6% expected return, but in the first year the actual return is only 5%. For just one year, the difference in ending portfolio value would be roughly 9%, which is disappointing but probably not terribly disruptive.

But what if the shortfall persists beyond one year? What does that do to your long-term objectives? Does it leave you behind in achieving your goals? If so, will you have enough time to make-up any shortfall? Can you save more, or will you be tempted to take on riskier investments? These are important questions to discuss with your advisor.

Another portfolio factor to review periodically with your financial advisor is the assumed long-term rate of inflation.

This may turn out to be a good-news exercise for investors. For years, the default assumption for long-term inflation was 3%. That was factored into the long-term growth in one’s cost of living. But 3% is now clearly too high, in our view. The Federal Reserve itself established a 2% inflation target, and the economy is struggling to hit that level. A rate closer to 2.5%, or even slightly lower, may be a more accurate long-term target.

The key point: A lower assumed inflation rate takes the pressure off one’s cost of living estimates, and it reduces some of the return pressure for your investment portfolio.

The next time you meet with your Ameriprise advisor, consider taking a few minutes to revisit the return and inflation assumptions built into your long-term financial strategy. Given these two variables can have big implications in achieving your goals, it’s better to find out sooner than later if you need to make a mid-course correction to stay on track.