Capital Market Assumptions vs. Actual Returns

Overview

Capital Market Assumptions (CMAs)

CMAs are predictions made by investment firms about future returns and risks of various asset classes. They are used for long-term financial planning but are not always accurate. As the saying goes, “it’s difficult to make predictions, especially about the future.” Even well-constructed CMAs are not a crystal ball and, when used inappropriately, can lead to suboptimal outcomes for investors.

Analysis of Forecasts vs. Realized Returns (2014-2023).

This analysis compares forecasts by 10 asset management and investment advisor firms for the 10-year period from 2014 to 2023. It includes major asset classes, though the number of forecasts for each asset class varies.

Equities (Panel A)

• US Equities: Forecasts ranged from 5.5% to 7.7% annualized, translating to 10-year cumulative returns of about 70% to 110%. However, the realized return was significantly higher at 11.5% annualized, or nearly 198% cumulative.

• Developed ex US Equities: Forecasts were just above 6% to just above 8% annualized, but the realized return was below this range at about 5% annualized.

• Emerging Markets Equities: Forecasts ranged from 7% to 11% annualized, but the realized return was roughly 4%, indicating overly optimistic forecasts.

US Fixed Income (Panel B)

• Inflation: Forecasts ranged between 2% and 2.5%, but the realized outcome was just below 3%.

• Cash Equivalents: Forecasts ranged between 1% and 2.5%, with a realized outcome just above 1%.

• Government Bonds: Forecasts ranged between 2% and 4.5%, but the realized outcome was between 1% and 1.5%.

• Investment-Grade Corporate Bonds: Similar to government bonds, forecasts were overestimated.

REITs and Commodities (Panel C)

• REITs: Forecasts were off by approximately 1 percentage point on average, with an error range of 0.3 to 1.8 percentage points.

• Commodities: Exhibited the greatest degree of error, with even the best forecast off by more than 3 percentage points and an average difference of a little over 5 percentage points.

Key Takeaways

• Forecasting Errors: Across all asset classes, there were notable discrepancies between forecasts and actual returns, with errors ranging from 0.1 to over 6 percentage points.

• Challenges in Prediction: The analysis highlights the inherent difficulties in making accurate long-term predictions, emphasizing the need for cautious use of CMAs in financial planning.