Prepare to Rely on Human Capital Rather than Financial Capital

In his most recent Investment Outlook letter, PIMCO founder Bill Gross suggests that investors need to prepare for difficult adjustments in a world of near zero real returns from financial capital

Gross describes the dying cult of equity that has evolved over the past century, and advises readers to expect future equity returns that are much less than 6.6 percent average real return (the “Siegel constant”) since 1912. 

Gross considers the 6.6 percent real return on stocks since 1912 to be an “historical freak, a mutation likely never to be seen again as far as we mortals are concerned.” 

This view is based in part on the notion that stockholders are approaching the end of an historic run during which their 6.6 returns have consistently exceeded the 3.5 percent growth in GDP and wealth. Gross questions how much longer equity owners can continue to benefit at the expense of labor, lenders and government. 

Add to this the that fact that we are likely in a low growth (sub 3.5 percent) world for the foreseeable future, and the idea of a future of 6.6 real returns becomes even less likely. 

Gross sees a future that consists of the following factors contributing to inflation adjusted returns on financial assets near zero: 

  • 2 percent returns on bonds 
  • 4 percent nominal returns for stocks 
  • A combined 3 percent nominal 
  • Inflation at or around 3 percent 

Zero real returns will result in meaningful adjustments to pension benefits, entitlement and returns from private wealth. 

Zero real returns on financial capital also highlights the importance of human capital

In the absence of returns on financial assets, the earnings we can derive from our labor may turn-out to be the primary lever for wealth creation. As Gross describes it, prepare to work harder for the money rather than letting the money do the work for you. 

Working longer and retiring later will likely become common considerations. Healthcare and education will also become increasingly important in an era when people will likely need to rely more on the wealth creating potential of their human capital. 

Source: PIMCO

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