Vanguard Sees Lower Returns, Higher Risk in Equities for 2018

December 5, 2017 — 2:25 PM EST

In what is seen as its most cautious outlook in the past decade, mutual fund giant Vanguard warned that 2018 will be marked by higher risks and lower returns, pressuring investments for equity and bond investors, largely those in the U.S.

Vanguard, which manages $4.8 trillion in assets, said in its annual outlook report that the biggest risks to the status quo – strong market returns and low volatility – are in the U.S., where a tight labor market will only become tighter. Vanguard expects unemployment to dip well below 4% and for wages to increase, along with increased inflation. As a result, the Federal Reserve will likely raise interest rates to at least 2% by the end of next year, injecting more volatility into the markets.

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"The secular forces of globalization, demographics and technology have for years served as the foundation for Vanguard's long-term outlook of modest growth and tepid inflation. As we head into 2018, investors should not mistake these secular trends for short-term cycles," said Joseph Davis, Ph.D, Vanguard global chief economist and head of Vanguard Investment Strategy Group, in a press release highlighting the outlook. "Instead, we anticipate a bit more volatility and an uptick in inflation in the year ahead, accompanied by more muted equity returns."

Vanguard's outlook for global stocks and bonds is being described by the money manager as the most "subdued" it has been in a decade, with Vanguard forecasting U.S. equity returns to be in the 3% to 5% range, which is much lower than the 10% annualized return generated over the past 30 years. Stocks and bonds outside the U.S. could see returns that are around 5.5% and 7.5%, highlighting the benefit of globally diversified portfolios in the years to come. The return on fixed income is muted at between 2% and 3% for the next decade, but at least it remains in positive territory.

With a lower rate of return projected for next year, Vanguard warned that investors should not reach for a "shiny" new investment strategy – such as overweighting emerging market stocks or high-yield corporate debt – in hopes of achieving better returns. Those strategies would not be enough to raise the returns to levels that investors saw in past decades, the money manager warned. "While our global market outlook suggests a somewhat more challenging and volatile environment ahead, investors can continue to find potential for long-term success by lowering their return expectations and maintaining a balanced and globally diversified portfolio. Saving more and keeping an eye toward costs are even more crucial elements of a successful investment strategy," Davis said.