The stock market is, unsurprisingly, unpredictable. Any investor with a few years under their belt knows the day-to-day fluctuations of a stock are nearly impossible to predict with any respectable level of accuracy. However, economists do have a model that can very accurately tell investors what the whole stock market will deliver on average over the long term.
Put simply, we can get a reasonable idea of how well stocks will do over the next decade based on the valuation and interest rates of today. For an investor with a diversified portfolio and a long-term time horizon, this information should be absolutely critical.
Here’s a deep dive.
Stock market forecast
Economists and professional macroeconomic investors have a model that forecasts stock market returns over the next decade. Every expert uses a variation of this model, but the elements are the same. They look at the current interest rate, stock market valuation, average dividend yield, probable dividend growth and expected inflation.
This allows economists at investment firms like Edward Jones to offer a forecast. As of July 2020, the team’s forecast for Canadian equities was 6-8% on average every year over the next 10 years. That means a $10,000 investment in the iShares S&P/TSX Capped Composite Fund (TSX: XIC) would be worth $21,589 by 2030 — a whopping 115% return.
If, like me, you’re skeptical of a prediction from a single source, rest assured that other sources offer a similar forecast. Brian Chang of Crusoe Economics forecasts roughly 6% on average annually for the next decade. The GuruFocus Buffett Indicator model indicates a 5.8% annual return over the same period.
In short, investors can confidently expect at least a 6% annual return over time.
Historic accuracy
Brian Chang claims his forecast has a 91% correlation with actual returns over the past two decades. Similarly, other economists also claim high correlation with actual returns when they test their model with historic returns.
Edward Jones says the long-term annual rate of return on the S&P/TSX Composite Index was 9.3% per year between 1960 and 2018. This means returns will be lower going forward. However, the stock market is still expected to outperform fixed-income securities and government bonds. For context, the 10-year Canadian government bond offers a paltry 0.64% yield.
The stock market truly is your best option.
Bottom line
The stock market is a volatile beast. That’s probably why only a minority of Canadians invest money in it. However, a balanced approach with a diversified portfolio and a long-term horizon is surprisingly predictable. A passive investor who simply pours capital into the TSX index should expect more or less 6% annually over the next 10 years.
Bear in mind, a 6% return is far higher than savings accounts. It’s also an excellent return, despite the economic crisis. With that in mind, maybe it’s time to add some stocks to your portfolio — preferably, an index fund or a few stocks from different industries.
