It's time to reset your assumptions
Let's get real about investment returns.
Adviser John De Goey did just that recently and he's now using a lower long-term rate of return when he builds portfolios for clients. Mr. De Goey has long been using Andex charts, a recognized investment industry source owned by Morningstar, to develop his return expectations. Going back to 1950, he said, the charts showed average annual stock market returns of 10.3 per cent in Canada over the past 60 years and 11 per cent annual gains in the U.S. market.
Then Mr. De Goey attended a pair of investment industry conferences recently. At the first, he learned that Canadian stock market returns are somewhat lower on average if you go back to the Great Depression. At the second, he heard four senior portfolio managers say they target real returns of just 4 per cent (after inflation). Upon his return to the office, he decided to reset his return expectations.
"I came to the realization that, in spite of my very best efforts, the assumptions I've been using are unduly optimistic," said Mr. De Goey, vice-president and associate portfolio manager at Burgeonvest-Bick Securities.
We should check our investment assumptions right now. It has been five years since the global financial crisis began and there's no sign yet the stock market will once again be a reliable generator of double-digit investment gains. But what's a realistic assumption at a time when stocks are up and down, and bonds typically offer returns in the sub-2 per cent range?
Mr. De Goey now uses a long-term real return of 4 per cent, or 6 per cent before an expected inflation rate of 2 per cent. As you'll see in the following survey of investment industry people, that's right in line with current thinking on returns in the 10 years to come.
The survey asked a dozen experts to estimate rates of return for the 10 years ahead on a diversified portfolio (60 per cent in stocks and 40 per cent in bonds), and to estimate the inflation rate over that period. For additional perspective, I invited my Twitter followers (my Twitter handle is rcarrick) to participate in an online survey that is summarized below.
Here's how to use the data below:
Step 1: Subtract the inflation rate from the estimated portfolio gain to get the real rate of return, which is the most meaningful gauge of performance.
Step 2: Subtract any fees charged by the investments you own and, if applicable, your adviser's. If you're a do-it-yourself adviser using exchange-traded funds, you might realistically lower your portfolio return by 0.5 to 0.75 of a percentage point. If you use mainstream mutual funds sold by an adviser, reducing your returns by 2 per cent makes sense.
Step 3: Remember that taxes will reduce your final returns to a varying extent.
For more personal finance coverage, follow me on Twitter (rcarrick) and Facebook (Rob Carrick).
WHAT THE EXPERTS SAY
NAME / TITLE / ESTIMATE OF 10-YEAR ANNUALIZED RETURNS* / ESTIMATE 10-YR. ANN. INFLATION RATE / COMMENTS
Sadiq Adatia / Chief investment officer a Sun Life Global Investments / 5% / 3% / "I expect lower returns and inflation in the first five years and then much higher in the later five years."
Tom Bradley / President, Steadyhand Investment Funds / 5%-6% / 2.5%-3% / For investment returns: 8 per cent from stocks and 2 per cent from bonds. On inflation, "no insights or prediction here. I'm using 2.5 to 3.0 per cent, but that's just because it's consensus."
John De Goey / Vice-president and associate portfolio manager at Burgeonvest-Bick Securities / 6% / 2% / After attending two investment industry gatherings recently, Mr. De Goey warned clients in a newsletter: "The strong consensus from both conferences is that 'growth' as we once knew it will not be back any time soon."
Keith Dicker / President and chief investment officer at IceCap Asset Mgt. / 2%-3% / 4% / Stocks will fall sharply over the next three years and then enter a bull market in which annual returns are as high as 15 to 20 per cent annually, according to Mr. Dicker. Government bonds will average a total return of 7 per cent the next three years and then start producing negative returns as inflation snaps back.
Andrew Guilfoyle / Adviser, Guilfoyle Financial / 6.6% / 2% / "I would suspect I'm more optimistic about equity returns over the next decade than many. But I think average retail investors' returns will be significantly lower than this, due largely to them jumping in and out of the market or 'hot' funds/investment managers at the wrong time." Mr. Guilfoyle sees stocks rising 9 per cent annually on average over the next decade, and bonds by 3 per cent.
Dan Hallett / Vice-president and director of asset management at HighView Financial Group / 6.5% / 2% / Worst case scenario of 2 per cent and best case of 8 per cent. Re inflation, "at some point when the economy has mopped up all the excess capacity and employment becomes fuller, inflationary pressures may well resurface, given all the stimulus that has been injected over the past few years."
Lori Livingstone / Portfolio manager at ScotiaMcLeod / 6% / 3% /"I use 8 per cent [for stocks] because we have had a decade of below average stock returns. And despite all the negativity at the moment, it is reasonable to expect a reversion to the mean return. A reasonable return [for bonds] would be 3 per cent."
Alexandra Macqueen / Financial industry consultant and co-author of Pensionize Your Nest Egg / 5.5% / 2.2% / "I do an awful lot of reading - these estimates are a consensus of the people I read."
Adrian Mastracci / Portfolio manager, KCM Wealth Management / 6.75% / 2.5% / "We divide the period into the first and second five years. Equities will return 6 per cent in the first period and 7.5 per cent in the second; bonds return 3.4 per cent in the first five years and 4.5 per cent in the second five years. Inflation is 2 per cent in the first five years, 3 per cent in the second."
Ted Rechtshaffen / President and CEO of TriDelta Financial / 6.5% / 2.5% / "The numbers [here] are what we would recommend if asked what we think it should be. Our goal is to have [clients'] reality outperform the plan about 70 per cent of the time. Essentially the numbers ... are a little worse than we think the reality will be. We think the real rate of return will be about 5 per cent."
Robert Sneddon / President and portfolio manager at CastleMoore Inc. / 7%-9% / 2% / "2018 is probably the outside range where we get back to a secular bull market again, where it's really broad based and all boats are floated." On inflation, the estimate is for a rate of less than 2 per cent for the next four years and above 2 per cent in the following six years.
Lieh Wang / Senior portfolio manager, Empire Life Investment Mgt. / 5% / 2% / "Since 1900, the nominal annualized return of stocks in Canada is just under 10 per cent and bonds delivered about 5 per cent. The recent 10 years have obviously been a very different story and coupled with our view of lower interest rates persisting for a longer period into the future, I would peg a forecast range of 4 to 6 per cent nominal annualized return for 60/40 balanced portfolio."
Investors like you / Twitter response to a short survey sent on investment returns and inflation / 5.5% / 2.7% / These are averaged numbers for 40 total responses. Investment return estimates were in line with the experts, but four see high inflation of as much as 6 to 7 per cent in the 10 years ahead.
*Diversified portfolio 60% stocks, 40% bonds
THE GLOBE AND MAIL