Conservatism bias is where one follows prior understandings or projections, without accounting for new evidence[1].
Many investors today may be following prior understandings or projections for asset class returns in creating financial plans, which may prove unrealistic to achieve.
In particular, some investors and financial planners are relying on return data dating back to when interest rates began their dramatic fall in the early 1980s.
Although there are myriad factors influencing returns other than just interest rates, this article will look at historical interest rate regimes and consider what it may mean for future portfolio returns.
In 1981, the effective Federal Funds Rate peaked just above 19%. This was a dramatic change in rates from 4.61% in January 1977 as the Fed attempted to tame inflation, which had been running close to 15% (an unthinkable number today).
As discernable in the chart below, rates have since then steadily plunged to a low of virtually zero since the Financial Crisis of 2007-8. While many factors influence asset prices, this dramatic drop in interest rates has been a tailwind for the economy and asset prices overall. Stocks, bonds, real estate and other assets have largely risen in value since the drop in rates began.
