Every December, my department holds a white elephant gift exchange. We place wrapped gifts on a table and take a number. When our number is called, we can select a gift or “steal” a gift that someone else has already claimed.

There’s usually an inverse relationship between the attractiveness of the package and the desirability of the gift. A year ago, for example, a colleague picked up a beautifully wrapped box festooned with a red satin ribbon. The package radiated holiday cheer. Inside was a ceramic cow.

Another colleague selected a battered box streaked with grime. It looked like something scavenged from the side of a road. Inside were Swiss chocolates and gift cards to the convenience store where we like to caffeinate. The gift was stolen in the next round.

Setting expectations

The white elephant gift exchange is mostly an occasion for goofiness, but the annual event may also teach us something about the relationship between expectations and satisfaction, a lesson that will be especially important for investors in the decade ahead.

Beautiful wrapping raises expectations, and high expectations can be a prelude to disappointment. In fact, research by Ravi Dhar and Nathan Novemsky, professors at the Yale School of Management, finds that, in some circumstances, gift wrapping reduces a recipient’s satisfaction with the gift.

From their financial crisis lows in March 2009 through November 30, 2014, U.S. stocks, as represented by the Dow Jones U.S. Total Stock Market Index, delivered an annualized return of more than 24%. The FTSE All World ex-US Index, a measure of non-U.S. stocks, returned almost 17% annualized over the same period. If we base future expectations on these recent returns, we may be picking a beautifully wrapped package that contains a ceramic cow.

Probabilistic goggles

Recently published, Vanguard’s economic and investment outlook for 2015 shares our projections for stock and bond market returns for the decade ahead. The future is uncertain, of course, so rather than a single forecast, Vanguard estimates the probabilities associated with a range of potential returns. (As Vanguard Global Chief Economist Joe Davis likes to say, our projections “treat the future with the deference it deserves.”)

Vanguard estimates that, over the next decade, the most likely outcome for a global equity portfolio is annualized returns in the 5% to 8% range. For global bond markets, the projection falls in the 2.0% to 3.5% range, in line with current bond yields. (To explore the full range of our expectations, including the methodology used to generate them, please see the paper.)

For a portfolio with 60% of its assets in global stocks and 40% in global bonds, the median estimate (half are above, half below) is annualized returns of 6%. From 1926 to 2014, a portfolio with 60% of its assets in U.S. stocks and 40% in U.S. bonds (international data don’t go back that far) would have returned about 8% per year.

A response to lower returns: Increased saving

If returns are more modest in the years ahead, we’ll have to rely on other levers to reach our financial goals. The most powerful—and reliable—lever is savings.

Suppose you hope to amass $500,000 for retirement. If your investments earn an average annual return of 8%, you would need to save about $1,930 per year over 40 years in the workforce. If average annual returns are 5%, you would need to save some $4,130 per year.

Vanguard recommends that retirement investors save 12% to 15% of their income, including any match in an employer-sponsored plan. Today, across all defined contribution plans administered by Vanguard, the average savings rate, including employer match, is about 10%.¹

Hope for the best, prepare for the worst

Maybe returns will be more generous than Vanguard’s outlook suggests. Maybe the need for increased savings will be less urgent. And maybe the beautifully wrapped packages at next year’s white elephant gift exchange will include the gifts of my dreams. But I wouldn’t count on it.

I’m inscribing a new epigraph at the top of my personal investment policy statement, courtesy of Barry Schwartz, a psychology professor at Swarthmore College and the author of The Paradox of Choice. “The key to happiness is low expectations.”

Thanks to Christine Kim for her help with this post.



¹ How America Saves 2014. Valley Forge, PA: Vanguard.