Tag Archives: inflation

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

Are low interest rates punishing savers? Hardly!

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Robb Engen, Boomer & Echo

By Robb Engen, Boomer & Echo

It’s easy to see how savers feel punished in today’s low interest rate environment. You have to look hard to find a daily savings account that pays more than one per cent.

Fixed income investments aren’t much better, with 5-year GICs barely touching 2 per cent. All of this means parking your short-term savings will do little more than keep up with inflation – you’re treading water, at best.

Rates have fallen steadily for a quarter century

We’ve seen a steady decline in rates for the past 25 years – around the time when the Bank of Canada adopted its inflation-control target to preserve the value of money by keeping inflation low, stable, and predictable. In January 1991, the overnight rate was 10.88 per cent, the interest paid on daily savings was 9.66 per cent, and inflation ran at 6.9 per cent. By 2002, the overnight rate fell to 2.25 per cent, daily savings interest dropped to 1 per cent, and inflation held steady at a now familiar 1.4 per cent.

Related: Can you succeed with an all-GIC portfolio?

So should we long for the days when GICs paid 10 per cent or more? Are low rates really  punishing savers? Hardly. Continue Reading…

The Single Best Investment

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singlebestBy Jonathan Chevreau

The Single Best Investment: Creating Wealth with Dividend Growth, is the title of a classic investment book first published in 2006 by Lowell Miller, who heads Miller/Howard Investments.

It came to my attention via Wes Moss, who I interviewed for an upcoming MoneySense column, whose book You Can Retire Sooner Than You Think we reviewed here at the Hub. I mentioned the book in passing last week in this MoneySense blog last week. That blog focused on asset allocation but provided a big hint about Miller’s philosophy: there’s no place for bonds in Lowell’s investment worldview.

The book’s first chapter sets the tone in its title: Say goodbye to bonds and hello to bouncing principal. Like many stock believers and bond haters, Miller takes it as a given that the investing environment generally includes inflation. Since “safe” investments like t-bills, bonds, money market mutual funds and CDs (Certificates of Deposits in his native USA; known as GICs in Canada) are all “poor investments because what they give is less than inflation takes away.”

Stocks are the only asset class likely to beat inflation in the long run, but the “price” of such an investment is volatility. Continue Reading…

Managing Inflation in Retirement

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Roger Wohlner, The Chicago Financial Planner

By Roger Wohlner,

Special to the Financial Independence Hub 

Inflation may seem like a tame or even non-existent threat. We are actually witnessing deflation in the price of oil and other commodities as I write this. Even so, it’s highly unlikely that inflation is dead. The U.S. economy continues to recover from the financial crisis and times of economic recovery are often a trigger for higher inflation.

An annual inflation rate of 2 per cent or 3 per cent over a period of years can seriously erode the purchasing power of your retirement nest egg.  At 2.5 per cent inflation, US$1 today will be worth approximately 78 cents in 10 years, 61 cents in 20 years, and 48 cents in 30 years. This could have a major impact on those entering retirement and those already in retirement.

Managing inflation in retirement is crucial;  here are some thoughts you need to consider. Continue Reading…

Why do we invest?

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Aman Raina, Sage Investors

By Aman Raina, Sage Investors

Special to the Financial Independence Hub

One day as I was perusing the world wide web, I came across a posting about DRIP investments, which ran in the new blog by PWL Capital’s Justin Bender.

What caught my eye had nothing to do with DRIP investments but more about a comment made at the end of article that really got me thinking. It said:

“…Investors should be focusing their attention to more important investment decisions that are likely to have a bigger impact on overall success (such as savings rate, expenses, risk, fees, taxes, and behaviour)…” 

Make no mistake, these are important factors in developing your investment ideology or strategy. However, these elements just get you into the game of investing; on their own they are not going to guarantee you will be successful. Continue Reading…