Robert Shiller’s CAPE ratio for projecting future returns is a great tool to be aware of. (Remember it’s a TOOL, though. Not a guarantee!)
CAPE stands for Cyclically Adjusted Price Earnings which ‘smooths’ out previous earnings and prices relative to inflation. The reason it’s important is that it doesn’t get too caught up in one specific year to gauge valuations.
For instance, in 2006 earnings were through the roof relative to prices. That would indicate that stocks were valued LOW and thus a great buying opportunity…right?
IN 2009 earnings dropped like a brick in water relative to prices and thus P/E ratios were through the roof, indicating stocks were WAY overvalued and should be sold, right?
WRONG! On both fronts.
And this is why the CAPE is such a good tool, but it takes away some of the year over year anomalies that transpire and instead levels things out over time.
The problem with CAPE though is that its been quite high, for going on a decade now, relative to historic norms. Thus, when Shiller revisits other times the CAPE has been this high, we get scary results.
.9% REAL returns for the next decade on average.
Will that come to frution? Anyone’s guess.
But what happens if we use one of the CAPE’s biggest crtic’s, Jeremy Siegal, numbers. Even then we get around a 3.5% Real return for the next decade.
Spit in the middle and we’re looking at 2%! YIKES!
Look, I’ve no clue what’s going to happen over the next 10 years. You don’t either. But I do know that you need to really be focused on things you can control.
1. EXPENSES -especially investment expenses. If we are going to get low returns, you simply can not afford 1% a year in investment fees. It’s simply not worth it.
2. Debt: Pay it off!
3. Social Security: DELAY, DELAY, DELAY!!! That’s 8% a year increase which you should not expect to get in the markets. Oh, Social Security also grows WITHOUT risk too!
4. Understand your cash flow. You need to know where your $ goes especially if you’re about to retire.
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