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What Are REAL Returns, And Can You Eat Them?

In this edition of our quarterly letter, we’re going to explore the difference between nominal and real returns, along with the impact of inflation. There’s also a story on a case we just finished which added $794,000 to a client’s bottom line, which had nothing to do with our investment performance.

Finally, we’ll revisit the outcome of last April’s signal from the 90% rule devised by Dan Sullivan of The Chartist, a technical stock market newsletter whom we have much respect for.

What Do You Mean By The Real Return?

Let’s face it.  The finance industry has a lot of technical jargon that can make concepts difficult to understand for the average person.  Learning about finance can be like learning a new language.  I’m certainly guilty as charged, as I know that I can be too “technical” when writing about technical analysis (excuse the pun).  For me, it’s easy to write about technical stuff, but sometimes it can be a challenge to turn that into simple concepts that most readers can understand.  That is an on-going goal.

In that aim, I thought I’d tackle the subject of nominal returns versus real returns.  A nominal rate of return is the amount of money generated by an investment before factoring in expenses such as taxes and inflation.

A real rate of return is the annual percentage return realized on an investment which is adjusted for changes in prices due to inflation or other external effects.  This method expresses the nominal rate of return in real terms (or inflation-adjusted terms) , which keeps the purchasing power of a given level of capital constant over time.

In simple terms, the real return is the nominal return, minus the inflation rate.  For instance, in 2016, the S&P 500 Index, expressed by using the Vanguard 500 Index Fund (VFINX) gained 11.82%.  The Consumer Price Index-U (CPI-U) was up 2.1%, so the real return for the year was 9.72%.  For some longer term context, below we’ve reproduced a chart showing the inflation rate back to 1962, courtesy of Ned Davis Research.

I also thought it would be fun, and useful, to re-visit a story I penned back in December 2007 on the subject of inflation.  Many of you who are local clients and friends know that my favorite breakfast joint is The Original Pancake House.  For about the last 15 years, I’d been taking our son, Adam, and then daughter, Caroline, nearly every Saturday morning to the Yorba Linda location.

In April of 2016, they lost their lease with the city of Yorba Linda and have been closed since then, but the Anaheim location is connected through family, and those owners established a new location in Whittier.  There is also one in Orange, but that ownership is unrelated.

In any case, back in 2007, the Yorba Linda location celebrated their 50th anniversary by rolling back prices for one day to 1957.  I reproduced their 1957 menu in our December 2007 newsletter, and compared them to the then current prices in 2007.  I’ve now updated the table with today’s prices, another 10 years later.  In the table below, I’ve computed the overall inflation rate since 1957, and for just the last 10 years.


Entree/Item 1957 2007 2017 Overall Inflation Rate Last 10 years
French Pancakes $0.90 $6.40 $7.60  3.62 1.73
Blueberry Pancakes $0.90 $6.10 $7.45 3.59 2.02
Buttermilk Pancakes $0.50 $4.95 $6.45 4.35 2.68
10 Dollar Cakes $0.65 $4.75 $5.85 3.73 2.10
Ham & Eggs $1.25 $7.25 $9.50 3.44 2.74
Golden Brown Waffle $0.50 $4.90 $6.45 4.35 2.79
Side Bacon $0.45 $3.40 $4.50 3.91 2.84
Side Ham $0.65 $4.15 $5.50 3.62 2.86
Orange Juice (large) $0.45 $3.20 $3.50 3.48 0.90
Coffee $0.10 $2.00 $2.75 5.68 3.24
AVERAGE 3.97% 2.39%

As you can see, this menu of breakfast items has averaged nearly a 4% increase during the last 60 years, but this rate of inflation has declined in the last 10 years to just under 2.40%.  In fact, the overall trend of inflation has been declining for over 25 years now, as shown in the chart below, courtesy of author Craig Israelsen.

Now, to get some perspective on the REAL returns from stocks and bonds, I’ve created a table below showing the annual returns from stocks and bonds along with the inflation rate, back to 1987.  To represent stock returns, we used the Vanguard 500 Index Fund (VFINX) and for bond returns, the Vanguard Total Bond Fund (VBMFX). Then we listed the annual inflation rate, and computed the real return each year for stocks and bonds in the far right columns.

Year Stocks Bonds Inflation Stock Real Return Bond Real Return
1987 4.71 1.54 4.41 0.30 -2.87
1988 16.22 7.35 4.42 11.80 2.93
1989 31.36 13.64 4.65 26.71 8.99
1990 -3.32 8.65 6.11 -9.43 2.54
1991 30.22 15.25 3.06 27.16 12.19
1992 7.42 7.14 2.90 4.52 4.24
1993 9.89 9.68 2.75 7.14 6.93
1994 1.18 -2.66 2.67 -1.49 -5.33
1995 37.45 18.18 2.54 34.91 15.64
1996 22.88 3.58 3.32 19.56 0.26
1997 33.19 9.44 1.70 31.49 7.74
1998 28.62 8.58 1.61 27.01 6.97
1999 21.07 -0.76 2.68 18.39 -3.44
2000 -9.06 11.39 3.39 -12.45 8.00
2001 -12.06 8.43 1.55 -13.61 6.88
2002 -22.15 8.26 2.38 -24.53 5.88
2003 28.50 3.97 1.88 26.62 2.09
2004 10.74 4.24 3.26 7.48 0.98
2005 4.77 2.40 3.42 1.35 -1.02
2006 15.64 4.27 2.54 13.1 1.73
2007 5.39 6.92 4.08 1.31 2.84
2008 -37.02 5.05 0.09 -37.11 4.96
2009 26.49 5.93 2.72 23.77 3.21
2010 14.91 6.42 1.50 13.41 4.92
2011 1.97 7.56 2.96 -0.99 4.60
2012 15.82 4.05 1.74 14.08 2.31
2013 32.18 -2.26 1.50 30.68 -3.76
2014 13.51 5.76 0.76 12.75 5.00
2015 1.25 0.30 0.73 0.52 -0.43
2016 11.82 2.5 2.1 9.72 0.40
AVERAGE  11.45% 6.16% 2.64% 8.80% 3.51%

For some additional context, the real return from stocks since 1926 has been about 7% annually, with a 10% nominal return and inflation of 2.9%, while intermediate government bonds have had a real return of about 2.4%, with nominal returns of 5.3%. In the most recent 30 years shown above, returns have been stronger than the historical average, with stocks averaging 11.45% and bonds 6.16% (note, there is a difference between average returns and compound returns).  With inflation lower than its long term average, real returns have been higher, with stocks at nearly 9% and bonds at 3.5%.

However, when I computed the averages for the last 17 years (2000-2016), it was a far different story.  The average return on stocks has been 6.04% while bonds have checked in at 5.01%.  Inflation has averaged 2.15%, well below the 30-year average.  As a result, real returns for stocks have dropped to 3.88% and for bonds to 2.85% in these last 17 years.


Looking backwards, if one had been using a balanced, moderate risk portfolio of 50% stocks and 50% bonds since 2000, the real return would have been about 3.36% annually, even starting at one of the most overvalued stock market junctures in history.

In most of the planning work we are using currently with clients, we’ve begun modeling future real returns at 1% and go from there.  It’s important to note that depending on the age of the client, these projections are trying to look out typically 20 to 30 years.  We remind everyone that nothing can look that far out into the future with any accuracy, even using Monte Carlo simulations (see, there’s one of those complex terms I was referring to earlier, which can be the topic of another newsletter).

However, we do feel that there are methods of looking at bonds and stocks that can have a decent degree of forecasting looking out 10 years.  Right now, the year-over-year inflation rate is running at 2.4% (see above chart from Ned Davis).  Ironically, the yield on the 10-year Treasury Note is also sitting at 2.4%.

We can’t know this, but let’s assume that inflation rises slightly in coming years, and averages 2.6% for the next 10 years.  If one only invested in Treasury Notes, the real return would be all of 0.2%.  But, we have a much more diversified bond mix which includes high yield corporate bonds and other strategies.  The yield on high yield corporates today is around 5.5%.  That doesn’t account for any defaults.  But, I think it is reasonable to achieve a 4% nominal return the next 10 years from our bond strategies.

That would imply a 1.4% real return from bonds.  Stocks are another story.  A number of valuation methods imply that from current levels, stocks will be quite fortunate to gain 3-4% annually in the next 10 years.  Assuming price/earnings ratios do not mean revert and are near current levels 10 years out, one might be fortunate to earn 4% annually, which also would imply a 1.4% real return.

In our work, we are mostly assuming 1% real returns.  It is not a forecast.  Our position is more from this angle—if our clients can achieve their spending goals with almost worst case outcomes going forward, they will be that much better off if in fact market returns are better.  We’d much rather people end up with more money than they anticipated, than the other way around.

Just so you don’t think our thoughts are grounded in a fairy tale, below we’re showing the forecasts from two prominent research firms, Grantham Mayo Van Otterloo (GMO) and Research Affiliates.  They regularly publish their forecasts of future expected returns for various asset classes.  The top chart below is from GMO.

This one is from Research Affiliates.

As you can imagine, there are differences in their respective outlooks.  About the only areas where they seem to agree are with U.S. bonds and emerging market stocks. Research Affiliates is suggesting less than 1% real returns for U.S. stocks, while GMO is forecasting negative real returns of of over -3% annually.   In other words, they both think that stocks are pretty expensive, and with bond yields starting from such low levels, real returns from fixed income are likely going to be less than average as well.

In conclusion to our original question of, “Can you eat real returns?” I think the answer is yes, but our dollars (purchasing power) are likely to be less in the next 10 years, not because of a significant increase in inflation, but rather because nominal returns from the traditional investments in stocks and bonds are likely to be lower.

It will be interesting to see what my chocolate chip pancakes, side of bacon and cup of coffee will run 10 years from now.  I’m willing to bet this.  The increase in cost will be much less than our medical insurance premiums from Aetna (yes, I’ve purposely stayed away from healthcare costs, perhaps the most expensive item for many of us).  Meanwhile, do yourself a favor and go have breakfast at The Original Pancake House.  Take a friend or a loved one, and enjoy your time there.  Don’t think about inflation, or your investments.  The odds are, once you go, you’ll go back, and then you can blame me for all the extra calories you’re consuming.

What We Do When No One’s Looking (The $794,000 Bump)

Last summer, we introduced this section to tell stories, in response to our daughter Caroline’s query of “Daddy, what do you do at work?”

This story involves life insurance, but the background is important so you understand how we were able to craft the solution.  I’ve had three variable life insurance policies since the early 1990s.  The first was from Prudential Insurance, while I was employed at Prudential Securities, and had a death benefit of $500,000.

Several years later, I purchased an additional $1.5 million variable life policy from Hartford Life.  When we formed TABR and began to use Fidelity as our custodian, I learned that Fidelity Life Insurance had a variable life contract, so for simplicity, I transferred both policies into a new, $2 million variable life policy.  The “variable” means that both your annual premiums can vary, and so can your yearly investment results, since the cash value is invested in mutual funds, just like in your IRA or taxable brokerage account.

This type of insurance is considered permanent insurance, and is designed to be there for my wife should I die, whether it be unexpectedly at an early age, or later in my 70s or 80s.  The premiums to properly maintain the policy were running in the range of $15,000 to $20,000 per year.  By 2014, the cash value of the policy had grown to about $434,000.

From a planning perspective, given that we have a son in college (graduating next week from NYU) and a daughter who is 7 years away, it was obvious that I would love to eliminate the expense of funding the policy, but wanted to keep the coverage.  At that time, through my reading and learning about new products and interacting with people in certain departments, I learned a few companies had a new product where I could transfer the policy and get a guaranteed, no lapse death benefit for the rest of my life, with no further premiums.  This was a really appealing solution.

So, I reached out to our contacts at Low Load Insurance Services in Tampa, FL.  Mark Maurer and his team at Low Load specialize in serving fee-only advisors like TABR. Mark steered me to a policy from Columbus Life, where I could eliminate the premium and have a $2.1 million death benefit guaranteed the rest of my life, dependent on my medical results.

Up to then, I had always attained a super-preferred rating, being blessed with good health thus far.  As luck would have it, Columbus Life lowered my rating a bit, since in the past three years, I’ve had two biopsies on my prostate, both of which thankfully have come back negative.  In the end, they offered me a death benefit of $1.975 million.  I took it, as giving up only $25,000 in death benefit was an easy trade for eliminating the annual premiums and having permanent coverage.

Armed with this experience, fast forward to last summer.  By being aware of the total situation of this client, we knew that the wife was 70 years old and had a $1 million permanent policy from Principal Life with about $520,000 of cash value and was paying annual premiums of $1200 into the policy.  Importantly, though, we delved further.  We requested an in-force illustration of the existing policy from Principal, and we discovered that if our client lived to age 94 or beyond, the policy would actually lapse without significant further premiums at that time.

In this case, we knew that this client’s mother had passed away a couple of years ago at the age of 100, so 94 was a distinct probability.  Our solution was to recommend the same Columbus Life policy that we had, which would guarantee the death benefit no matter how long she lived, and also eliminate all future premiums.  But here’s the kicker.  Columbus Life was willing to increase the death benefit from $1 million to $1.72 million, depending on the medical rating.

Guess what?  Our client earned a preferred rating, and the final policy was issued last month for $1,794,000.  The end result was that we have been able to increase the balance sheet for our client (and their heirs) by $794,000 and save them $1200 a year in premiums, and it has absolutely nothing to do with how their portfolios with us are doing.

Obviously, we can’t work magic like this in all situations, but it is amazing what can be done when we know everything about a client’s situation.  I might add that we did not receive any compensation for recommending, guiding and implementing this solution. The team at Low Load does receive a commission, but we don’t.  And, we certainly don’t receive anything back from Low Load.  This is an example of being a true fiduciary, and doing what is in the best interest of our client.  This is part of the planning work we do, and is all wrapped under the fees we receive for managing assets.

As this story shows, there is a lot of value we can add to clients’ lives above and beyond “how’s my portfolio doing?” but you have to be engaged with us.

Technical Update on the Stock Market

Last spring, the stock market generated unusual upside momentum in what is commonly called a “breadth thrust.”  We featured some studies from both Ned Davis Research, along with Dan Sullivan, the long-time editor of The Chartist newsletter.

Sullivan created what he calls the 90% rule.  A BUY signal is generated when 90% or more of the stocks on the NYSE manage to rise above their respective 50-day moving averages.  The theory behind this is that such an event is a strong indication that the market has managed to generate enough thrust to continue rising for several more months.

Since 1970, there have been only 11 such signals, with the most recent in April 2016.  That signal just completed the one year period, and the results for all signals are summarized below.  The numbers represent the gain in the S&P 500 Index (without dividends).

Signal Date After 3 mos After 6 mos After 9 mos After 1 Year
9-9-1970 8.1% 20.1% 21.1% 21.75%
1-5-1972 5.8 4.9 5.6 10.82
1-29-1975 10.8 14.1 15.7 29.57
1-7-1976 8.8 10.5 10.2 11.77
5-28-1980 8.9 25.4 17.1 19.08
9-14-1982 11.6 22.5 34.5 34.32
2-12-1991 2.8 6.2 8.5 14.12
6-4-2003 4.2 8.5 17.1 13.81
4-29-2009 11.7 22.0 22.9 38.13
10-13-2010 8.9 11.6 11.8 2.16
4-19-2016 2.99 2.07 7.75 11.29
AVERAGE 18.08%

The latest signal was completed a few weeks ago, and it gained just over 11%.  All 11 past signals have averaged an 18% gain one year later.  These don’t happen very often, but when they do, they have been pretty powerful.  But what about now?

As we’ve been conveying in monthly updates, fundamental indicators suggests stocks are expensive, and sentiment indicators suggest there is too much optimism, both of which are long term negative.  But overall, the technical evidence is mostly positive, so until that changes, we will remain moderately positive on the markets.

Stanley Cup Fever

As most of you know, I am a sports nut with my teams, and I’m not sure it gets any better than the Stanley Cup Playoffs, especially in person.  My wife and I have had Anaheim Ducks season tickets since Day One in 1993, six rows from the ice, on the blue line, and right above the visitor locker room tunnel.  Pretty hard to beat.

Anaheim has just advanced to the Western Conference Finals vs Nashville, and with four more wins, they would reach the Finals for the third time in their history.  As a sports fan, when one gets older, you realize how precious these moments can be.  My SF 49ers have won five Super Bowls, but nothing since 1995, and who knows, they may never win another one while I am alive.  Chicago Cubs fans know all about waiting a long time.

Last Friday night, I was at Game 5 of the Ducks/Edmonton series, and witnessed history, at maybe the most exciting sporting event I’ve ever been to.  The Ducks were losing 3-0 with 4 minutes left in the game.  They pulled the goalie and scored three times in just over 3 minutes to tie the score with 15 seconds remaining.  They went on to win in double overtime, 4-3.  It was the first time any team in history had won in the playoffs while trailing by 3 goals with less than 4 minutes left in the game.  The game lasted nearly five hours, and we were standing for both overtimes without ever sitting down.

I cannot describe the emotions.  Sudden death overtime is incredible.  Every shot is potentially the game-winner.  My voice was pretty much shot for five days.  Below is a photo of myself with an Edmonton fan who was sitting nearby, and had come from Edmonton to attend the game with his wife.  They had identical jackets on and obviously stood out, because there aren’t many people who would go to a hockey game dressed like that.

They were a fun couple, and I welcomed them to Anaheim.  There were many Edmonton fans at the game.  Anyone who has that kind of passion for their team has my respect, and the fans from Edmonton are fantastic.

Many of you who know me well might be looking at that photo and going, hey, I thought you were a Dallas Stars fan?  Don’t worry—underneath my Ducks jersey was a Dallas Stars shirt.  Had my Stars been in the playoffs, I would have been wearing a Stars jersey.  But the Ducks are my # 2 team.

By the way, I texted this photo from the game to my wife, telling her I liked his outfit so much that I’d ordered a set of Dallas Stars suits for us so we could wear them to the game.  Her response—“that would be grounds for divorce.”  You think she has a sense of humor?  Let’s Go Ducks!



Bob Kargenian, CMT

TABR Capital Management, LLC (“TABR”) is an SEC registered investment advisor with its principal place of business in the state of California.  TABR and its representatives are in compliance with the current notice filing and registration requirements imposed upon registered investment advisors by those states in which TABR maintains clients.  TABR may only transact business in those states in which it is notice filed, or qualifies for an exemption or exclusion from notice filing requirements.

This newsletter is limited to the dissemination of general information pertaining to our investment advisory/management services.  Any subsequent, direct communication by TABR with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides.  For information pertaining to the registration status of TABR, please contact TABR or refer to the Investment Advisor Disclosure web site (www.adviserinfo.sec.gov).

The TABR Model Portfolios are allocated in a range of investments according to TABR’s proprietary investment strategies. TABR’s proprietary investment strategies are allocated amongst individual stocks, bonds, mutual funds, ETFs and other instruments with a view towards income and/or capital appreciation depending on the specific allocation employed by each Model Portfolio. TABR tracks the performance of each Model Portfolio in an actual account that is charged TABR’s investment management fees in the exact manner as would an actual client account. Therefore the performance shown is net of TABR’s investment management fees, and also reflect the deduction of transaction and custodial charges, if any.

Comparison of the TABR Model Portfolios to the Vanguard Total Stock Index Fund, the Vanguard Total International Stock Fund and the Vanguard Total Bond Index Fund is for illustrative purposes only and the volatility of the indices used for comparison may be materially different from the volatility of the TABR Model Portfolios due to varying degrees of diversification and/or other factors.

Past performance of the TABR Model Portfolios may not be indicative of future results and the performance of a specific individual client account may vary substantially from the composite results above in part because client accounts may be allocated among several portfolios. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable.

The TABR Dividend Strategy presented herein represents back-tested performance results. TABR did not offer the Dividend Strategy as an investment strategy for actual client accounts until September/October 2014. Back-tested performance results are provided solely for informational purposes and are not to be considered investment advice. These figures are hypothetical, prepared with the benefit of hindsight, and have inherent limitations as to their use and relevance. For example, they ignore certain factors such as trade timing, security liquidity, and the fact that economic and market conditions in the future may differ significantly from those in the past. Back-tested performance results reflect prices that are fully adjusted for dividends and other such distributions. The strategy may involve above average portfolio turnover which could negatively impact upon the net after-tax gain experienced by an individual client. Past performance is no indication or guarantee of future results and there can be no assurance the strategy will achieve results similar to those depicted herein.

For additional information about TABR, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein.  Please read the disclosure statement carefully before you invest or send money.

A list of all recommendations made by TABR within the immediately preceding one year is available upon request at no charge. The sample client experiences described herein are included for illustrative purposes and there can be no assurance that TABR will be able to achieve similar results in comparable situations. No portion of this writing is to be interpreted as a testimonial or endorsement of TABR’s investment advisory services and it is not known whether the clients referenced approve of TABR or its services.


By Bob Kargenian | Quarterly Newsletter