There is a Rob Carrick column in the May 23rd Globe & Mail. You can see it here and you should do so. As the title suggests it is a worthwhile and well documented discussion of projected investment returns. The implied thesis being that you better get this right because bad things happen if you miss by much.
Another intimation is that you probably should mistrust people who use much higher rates of return in their plans.
There is much to value in the article and some points that I wish had been there. First the values:
- Studies show that based upon history, holding out a reasonable future rate of return for a Canadian equity portfolio that exceeds 6.3% may be optimistic. Bonds are 3.9%
- There is a link to a useful document “Projection Assumption Guidelines” that supplies some number support and very usefully contains a mortality projection at Page 11. It states that for a male and female aged 50, the probability is 50% that at least one of them will live to 92. There is a 10% chance that at least one will live to 100. Long term planning indeed.
- People should try to be reasonable when they project their rates of return. There is risk of running out of money if you guess a rate that turns out too high or if you live too long.
- It would be easy to be over optimistic
There are unincluded things to think about and some of them may matter:
- The future will be variable no matter how carefully you calculate the average of the past. While the past can give us ideas about the future, it cannot provide hard assurances. Some investors may take the well-constructed average as an expectation or promise. Like a GIC. How will they behave after the first bad year? Some will quit. Historically, the return for investors is much less than the market itself because people tend to buy when things have gone up and sell when they are going down. Exactly backwards.
- There should be a distinction between portfolios that are built to accumulate money and ones that are built to provide income. Early losses will have a much more significant affect on the future for income oriented portfolios than will early losses in an accumulation situation.
- The 6.3% and the 3.9% number are still subject to variability. The range of that expectation should be more obvious. Averages generally don’t mean a lot unless you know the variability range.
- The expected yield number is for Canada. If someone invests elsewhere, the number will be different and so will the variability. Even the Canada Pension Plan does not invest exclusively in Canada.
- Yield is an important variable, but it is not the only one that matters. Time is crucial too. If you start a little earlier you have endpoint flexibility. If you save $3,000 per year plus 2% inflation all at 6.3% for 30 years you will have about $330,000. If you started two years earlier, at the same point in the future you will have 330,000 if you make only 5.5%. Starting a little earlier reduces the effects of yield variability. You may reach your goal a lot earlier than you planned or maybe around the time you need the money. You can manage time more easily than yield.
The idea of the article is sound and the purpose of standardizing advice is possibly acceptable. The problem will arise when people realize that while there may be a standard yield, there is no standard client. Risk tolerance, knowledge, tax position, needs, and priorities, are all over the place. If the standard becomes an important regulatory thing, then clients who do not match the paradigm will suffer.
Well constructed statistics are not a good substitute for professional judgment.
Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.