In the late 1990s, many investors had double-digit returns on their investments. Then the Internet bubble burst, and they incurred losses.

Markets that fluctuate to this extent make it hard for investors to plan their financial futures. A sound financial plan serves as a roadmap to reach long-term financial destinations. However, you need to have reasonable estimates of the long-term stock and bond market returns.

If your return estimates are too optimistic, for example, you run the risk of not being able to retire on time or pay for your children's higher education. If they're too pessimistic, you may sacrifice more of your current lifestyle than you'd like while saving for your long-term goals. Like the axiom "garbage in, garbage out," you can't use unrealistic assumptions to determine realistic outcomes, and this is especially true when developing your long-term financial plan.

To help minimize the "garbage in" aspect, the Schwab Center for Financial Research estimated long-term returns on stocks and bonds.

Our study shows that the average return on large-cap stocks might be about 8.2 percent per year in the long term (which we define to be 20 years)

Mid/small-cap and international stocks are estimated to return about 9.8 percent and 8.3 percent, respectively.

Bonds are estimated to earn about 4 percent per year in the long term.

These estimates are significantly below the historical returns on large-cap stocks and bonds of 11.1 percent and 8.5 percent, respectively, during the period of 1970-2007. Of course, these are estimates of average returns in any one year. Stocks and bonds may earn far more or far less. And remember, it's a good idea to plan using more reasonable return estimates.

Why are the estimates below historical averages? There are two reasons.

Our estimate of long-run inflation is 2.6 percent, about 2 percentage points below the actual inflation rate during the 1970-2007 time period.

Current and expected interest rates are much lower than what's transpired historically, especially compared to the high interest rate environment of the 1980s.

So, what can you do in a single-digit return environment? Thanks to the power of compound returns, what you do today can have big implications on your ability to meet long-term goals. Try to resist the temptation of doing nothing in the hope that market returns will be higher than anticipated. If they are, that will be a bonus. But it's far better to plan for a more realistic scenario.

Here are a few things you can do. First, while it's always wise to avoid unnecessary fees and taxes, it's even more important in a lower-return environment. Second, if you don't have a long-term financial plan, it's a good time to put one together.

Stocks are estimated to provide higher returns than bonds in the long term, but the premium for investing in stocks isn't as high as it has been historically. Stocks, however, are still the investment with the greatest potential for growth and risk to principal.

Important Disclosures

Actual returns will vary from our estimates. The information presented herein is general in nature and is for informational purposes only.

The author is vice-president and investment manager of Research at Charles Schwab.

(HK Edition 06/05/2008 page3)