The next few years are going to hurt

Some economists are predicting an era of slow growth for the foreseeable future, and if they are correct, that would have significant implications for investors. Last week, the Commerce Department's preliminary estimate of the rate of increase in the gross domestic product in the third quarter was 1.5%. That was down dramatically from the 3.9% rate in the second quarter, but substantially higher than some predictions by economists, such as Goldman Sachs' estimate of a 1% increase and the Atlanta Federal Reserve Bank's call for only a 0.9% increase. They are concerned about the economic slowdown in China, one of the biggest customers for U.S. exports of goods and services, and about Japan's and Europe's weak economies. They also are concerned about weak investment by U.S. companies and slow productivity growth. Slow population growth also is considered a contributor to slow economic growth, and the U.S. replacement rate (number of births per woman) dropped to 1.88 in 2012 from 3.65 in 1960. In China it has dropped to 1.66 and in Japan to 1.41 in the same period, suggesting long-term growth problems. The real GDP growth rate in the U.S. has been below par since 2011, when it was 1.6%. It was only 2.3% in 2012, 2.2% in 2013 and 2.4% in 2014. It did not top 2.4% until the second quarter of this year, when it shot up to 3.9% after registering only 0.6% in the first quarter. The average growth rate since 1948 has been 3.23% per year. Many economists expect the economy to struggle to top 2.5% a year for the next few years, especially if the Federal Reserve raises interest rates bit by bit over those years. Rising rates generally serve to slow the rate of economic growth. Slow economic growth would hit investors in multiple ways. It means low stock market growth because corporate earnings, and hence stock prices, can't grow faster than the economy. It also means low interest rates. Both would be bad for retirees and those trying to accumulate assets for retirement. For retirees, low rates and low equity returns increase the danger of outliving their resources, unless they reduce their lifestyles. In addition, slow growth likely would mean low inflation, and that in turn would mean no increase in Social Security. As we saw this year, Medicare contributions could increase. For workers, low equity returns would make it much harder to accumulate the retirement nest eggs they eventually will need. What can advisers do? They must watch the trend in the GDP growth rate and prepare their clients for the possibility of slow growth. Talk to clients and prepare alternative financial or investment strategies.

TEMPER EXPECTATIONS

If advisers see the rate of GDP growth remain low — below the historic 3.23% rate — the first step should be to lower client expectations about investment returns. The next step would be to encourage retiree clients to reduce their lifestyles if possible. Discretionary spending should be cut back until economic growth improves, and with it, expected investment returns. Working clients should be encouraged to increase their savings rate. What investment returns are unlikely to produce, savings must provide if a comfortable retirement, or other financial goal, is to be achieved. However, it will be difficult to increase the savings rate with pay increases expected to be small, as they have been for the past five years. For clients of an appropriate age — those with many years before retirement — advisers might suggest more risk taking to perhaps earn higher returns. Higher-risk investments do not always result in higher returns than lower-risk portfolios, but over the long run, they usually do. Long-term slow economic growth is not inevitable, but faster growth will depend not only on smart economic management in this country, but also in the nation's major trading partners so they too break out of their slumps. It is only prudent that advisers and their clients prepare to adapt their financial and investing plans in case the slow growth continues for more than a year or two.