All posts by Robb Engen

Protecting investment returns from Inflation

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Prices Increase Showing Financial Report And Economy

By Robb Engen, Boomer & Echo

Special to the Financial Independence Hub

Earlier this year, the Financial Planning Standards Council (FPSC) updated the numbers it uses for projected investment returns and inflation. Financial planners use these numbers as guidelines when projecting retirement needs and income for their clients.

The FPSC’s latest guidelines for 2015 peg annual inflation at 2 per cent and make the following assumptions for investments returns (nominal returns, not adjusted for inflation):

  • Short term: 2.90 per cent
  • Fixed income: 3.90 per cent
  • Canadian equities: 6.30 per cent

Portfolio return assumptions

Planners (and investors) need to consider inflation in their retirement projections, so these numbers should be adjusted down by 2 per cent.

We also need to account for investment fees and expenses in order to calculate the net portfolio returns. The FPSC assumes the majority of Canadians are invested in mutual funds and therefore use a management expense ratio of up to 2.25 per cent for Canadian equity investments and 1.50 per cent for the fixed-income security portion.

This chart shows net portfolio returns (after fees, but before inflation) for three types of investors: conservative, balanced, and aggressive:

FPSC guidelines

Once adjusted for inflation these returns range from 0.80 per cent annually for the conservative investor to 1.70 per cent for the aggressive investor.

Do those numbers sound realistic? Conservative?

According to data collected by the Million Dollar Journey blog (and pulled from online financial resource, Money Chimp), the compound annual growth rate after inflation for the S&P 500 during any 30-year period dating back to 1950 was between 4.32 per cent and 8.42 per cent.

It appears as though the new FPSC guidelines are being cautious with future investment returns; although keep in mind they’re using Canadian equity markets in their assumptions, not U.S. or international markets. These guidelines also use the highest average investment expenses – which is unfortunately true for most Canadian investors – to calculate net portfolio returns.

Projecting returns for my clients

When projecting investment returns for my clients I use 5 percent annual growth for investments and a 2.5 percent annual target for inflation. That leaves a net return of 2.5 per cent annually: after inflation, but before investment costs.

Now keep in mind that most of my clients have switched from expensive bank mutual funds into low cost index funds or ETFs,  so their investment fees and expenses are a fraction of what the FPSC uses in its guidelines.

For example, a portfolio of TD e-Series funds with 25 per cent allocated to each of the Canadian index, U.S. index, International index, and Canadian bond funds has an average MER of just 0.42 per cent. If we use those costs for the aggressive investor in the FPSC guidelines then the net portfolio return now equals 5.2 per cent after costs and 3.2 per cent when adjusted for inflation. Not bad.

Assumptions for my own portfolio

For my personal retirement planning assumptions I use an 8 per cent nominal return on my investments (remember, I’m 100 per cent in equities – both domestic and international – with my two-ETF solution).

The total costs for my portfolio each year is just 0.29 per cent, which leaves a net portfolio return of 7.71 per cent. I peg inflation at 2.50 per cent annually. That leaves inflation adjusted investment returns of 5.21 per cent for my retirement portfolio.

Why costs matter

The main takeaway from looking at these guidelines shouldn’t be which number to arbitrarily attach to your projected investment returns in order to boost your retirement income. Even inflation, although real, is largely out of your control.

What you can control is your investment costs. Fees matter; and the difference between a low-cost portfolio of index funds and a smattering of expensive bank mutual funds could mean the difference between your portfolio handily beating inflation over time or just treading water and barely keeping up.

What assumptions do you use when projecting investment returns and inflation?

RobbEngenIn addition to running the Boomer & Echo website, Robb Engen is a fee-only financial planner. This article originally ran on his site on July 26th and is republished here with his permission

How pairing fee-only planners and robo-advisers can save you money

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Woman meeting financial adviser in officeCute Robot

By Robb Engen, Boomer & Echo

Special to the Financial Independence Hub

The financial services industry would have you believe that individual investors don’t want to pay upfront for investment advice – in fact, the industry claims that investors prefer to pay for financial advice through fees that are part of their mutual funds.

But we all know mutual funds in Canada cost too much and the relationship between investors and financial advisors is mostly transactional in nature. Embedded commissions and trailer fees might make sense for investors who are just starting out, but over the long term this conflict of interest will be expensive and lead to poorer outcomes for investors.

An unconventional pairing

With the relatively new arrival of fee-only financial planners – advisors who don’t sell products but offer unbiased and objective financial advice for a set fee – and the emergence of robo-advisors – online investment management services – there is an opportunity for Canadians to access a better form of financial advice that costs less than the traditional bank advisor-mutual fund model.

That’s right, pairing a fee-only financial advisor with a robo-advisor (or DIY, if that’s your thing) can actually save you money and lead to better investor outcomes.

Here’s an example Continue Reading…

Why millennials should use multiple streams of income as their emergency fund

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cash flow, business concept, 3d render

By Robb Engen, Boomer & Echo

Special to the Financial Independence Hub

Millennials need to develop an entrepreneurial spirit in order to succeed in today’s economy. Gone are the days when you could graduate debt-free, get a job with a stable employer, work for three decades and retire with a healthy pension.

Today’s workers change jobs every four to five years, and they’re no stranger to layoffs due to budget cuts and downsizing. Full-time continuing employment has been replaced by year-to-year contracts, meaning there’s little chance of latching onto a pension. A good health and benefits package might even be a stretch.

 Related: On job security and preparing for the worst

A traditional emergency fund meant setting aside 3-6 months worth of expenses to get you through a long period of unemployment. In real terms that meant having $10,000 – $20,000 cash sitting there earning next to nothing in interest.

 Building multiple income streams

But a better way for Millennials to combat the threat of job loss – or job uncertainty – is to build up multiple income streams outside their traditional day jobs. Continue Reading…

The parable of the twins (RRSP vs TFSA)

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By Robb Engen, Boomer & Echo

Special to the Financial Independence Hub

Fashionable girls twins walk in the street

There’s a popular story told by banks and financial authors to encourage people to start saving for retirement at an early age. It’s called the Parable of the Twins and it goes something like this:

One twin puts aside $3,000 every year into his tax-free savings account starting at age 22, and stops at 32 – never adding another penny to the account. His sister starts saving $3,000 annually at age 32, and continues until 62. Who has the larger nest egg?

Related: How much of your income should you save?

You know how this story goes by now. Assuming an annual return of eight per cent, the twin brother wins hands-down. He ends up with $437,320 in his TFSA, compared to his sister’s $339,850, even though he contributed $60,000 less than his sister.

It’s a ubiquitous tale, but one that resonated with me at a young age. I was drawn to the awesome power of compounding – how money grows exponentially over time. Continue Reading…

What’s on the Menu? Engineering a better outcome for investors

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Depositphotos_50578301_xsBy Robb Engen, Boomer & Echo

Special to the Financial Independence Hub

When I worked in the hospitality industry our hotel group placed a large emphasis on the profitability of its restaurants and catering departments. Considerable effort was made to drive overall food costs down while at the same time creating a sales culture that pushed the highest margin items in order to boost revenue.

One of the most effective ways to do this was through a process called menu engineering. Before hitting it big by turning around struggling nightclubs in the reality show Bar Rescue, Jon Taffer was a highly sought-after speaker and consultant in the hospitality industry. At the top of Taffer’s legendary revenue growth plan for restaurants and bars is the concept of menu engineering. Here’s how it works:

Restaurant owners divide their menu items into four main categories:

  • Stars – Stars are extremely popular and have a high contribution margin. Ideally Stars should be your flagship or signature menu items.
  • Plow horses – Plow horses are high in popularity but low in contribution margin. Plow horse menu items sell well, but don’t significantly increase profit.
  • Puzzles – Puzzles are generally low in popularity and high in contribution margin. Puzzle dishes are difficult to sell but have a high profit margin.
  • Dogs – Dogs are low in popularity and low in contribution margin. They are difficult to sell and produce little profit when they do sell.

Continue Reading…