With apologies to Buzz Lightyear, there seems to be a fair bit of cognitive dissonance in the world. Over the years, advisors have collectively convinced their clients that it would be reasonable to expect high single digit returns on a fairly traditional (say 70% stocks; 30% bonds) portfolio. I got a call this week from a fellow who told me that, as a former wholesaler for the industry, he “knew” that a 7% to 9% long-term return was a reasonable expectation. I didn’t have the heart to tell him it isn’t. Some day soon, I’ll have to break it to him.
What do you suppose has happened to the efficient frontier in the recent past? As a reminder, the efficient frontier is a concept pioneered by Harry Markowitz in the 1950s: “efficient” because it is optimal and cannot be improved upon; a “frontier” because you cannot go beyond it. Like infinity. It is the theoretical model of the best return you could plausibly expect for any given level of risk.
Historically, stocks have gotten returns that are about 5% higher than bonds. Bonds, for their part, have averaged about 3.5% over the post-world war II era. So, that’s around 3.5% for bonds and 8.5% for stocks. At a 70/30 split, that’s something like 7% return for a balanced portfolio using historical index returns. Those are historical numbers. Of course, if products and financial advice cost (say) 2%, the expected return is more like 5%.
Efficient Frontier has shifted downward
The thing that very few advisors mention, in my personal experience, is that the efficient frontier has almost certainly shifted downward. Bonds are now more likely to earn something like 1% and stocks, with valuations that are approaching generational highs, are, over the foreseeable future, likely to earn a premium that is less than the 5% historical spread. Jeremy Grantham at GMO has gone so far as to project that virtually all asset classes have a negative expected return over the next seven years. Continue Reading…
Author and Advisor’s advisor Nick Murray. NickMurray.com
By John De Goey, CFP, CIM
Special to the Financial Independence Hub
I was on a cross country flight recently and I re-read a book called “Simple Wealth, Inevitable Wealth” by Nick Murray, a former rock star speaker who was beloved by the financial advice industry – mostly because he constantly told his advisor audiences that they are great, do important work and are worth every penny they make. The book was written 20 years ago and, unlike the other books by Murray, was written expressly for investors. Reading it again provided both a nostalgic stroll down memory lane and an enlightening insight into how much the financial services industry has changed in the past generation. Some parts of the book have held up well. Others… not so much.
The risk of outgrowing your capital
I’ll begin with the positive. The good news is that I still find it refreshing to read Murray’s perspective on the perverse way the media defines risk. He simply, compellingly and eloquently walks readers through the very real risk of outliving your capital as a result of a reliance on the quaint notion that bonds are “safe”. Safety, according to Murray, is having a pool of capital that you cannot outlive – and putting a significant portion of your life’s savings can significantly impede that outcome becoming a reality. I was also heartened by his acknowledgement that there are false dichotomies and that the real decision in the ongoing ‘debate’ between active and passive approaches is really a choice between the more relevant considerations of product cost. Murray also writes persuasively about the need for specific, measurable, time-bound goals that help to focus the mind and guide in principled decision-making. Best of all, Murray names and blames what I believe to be the biggest culprit in most peoples’ failure to meet their financial goals: themselves. More specifically, their own behaviour.
There are also a few things that cause me to shake my head in disbelief, however. The most obvious of these are the return assumptions that he puts forward as being reasonable. Granted, the numbers he uses are based on historical data, but he does relatively little to explain that real returns are fairly constant and that a portion of all nominal returns is inflation. While he doesn’t expressly tell people what inflation rate to expect, he does note that there is historically about a 5% premium for stocks over bonds. He uses 11% as a proxy for expected stock returns and 6% for bond returns. To put that in perspective, I currently assume inflation to be 2% with a 5% real return for equities (7% nominal) and a 0% real return (2% nominal) for income. How times have changed, now that everyone has re-calibrated their expectations toward a low-growth, low-inflation environment for the foreseeable future.
Sustainable withdrawal rates
Then there’s the related question of a sustainable retirement withdrawal rate. Murray uses 6%. Many years ago, I remember people talking about the real rate being 5%. For the past number of years, I’ve been using 4%. Note that my current withdrawal rates are actually more aggressive/ less forgiving than Murray’s. You’re much more likely to not run out of money withdrawing 6% from something that’s earning 11% than to withdraw 4% from something earning 7%. Financial planning is easy when your assumptions are based on a rose-coloured past rather than a murky future.
The thing that struck me the most, however, was his admonition to readers (remember, Murray is writing to ordinary investors here) to focus on first principles. Everyone knows the old ‘life’s like that’ story about getting a young child an expensive present for Christmas or a birthday only to have that child spend more time playing with the box that the gift came in than with the gift itself. Continue Reading…
‘Tis the season for the annual investment outlook, with a new year and some might argue a new decade ahead of us. While some pundits hold fire on their prognostications until January, a few big-name investment firms have just come out with their 2020 prognostications.
Among the early entrants was Franklin Templeton, which provided its predictions last week in Montreal and again yesterday (Dec. 10th) in Toronto. Also yesterday, Vanguard put out a release headlined Economic and Market Outlook 2020: Lower Growth Expectations in the New Age of Uncertainty.
Franklin Templeton is a well-known manager of actively managed mutual funds, and has now been in Canada for 65 years, going back to Sir John Templeton’s famous Templeton Growth Fund. Vanguard is best known for its “passive” or indexing approach to investing, both through index mutual funds and ETFs, although it is also an active manager. But their respective outlooks for the next year and decade are not too different, with investment returns projected to stay positive, albeit with cautions to investors not to expect quite as strong returns as they have received in the last decade.
Vanguard said global growth is set to slow in 2020, driven by US and China trade concerns and continued political uncertainty leading to depressed global economic activity.
Todd Schlanger, senior investment strategist at Vanguard Canada, said: “Investors should prepare for a lower-return environment over the next decade, with periods of market volatility in the near-term. We expect uncertainty stemming from geopolitics, policymaking, and trade tensions to undermine global growth over the coming year … For Canada, the picture is slightly rosier, with a resilient labour market and robust wage growth leading to growth levels stronger than most developed economies in 2020, with a slight improvement over 2019.”
Vanguard’s main bullet points were these:
It forecasts continued slowdown in global growth but Canada will be a bright spot among developed economies: Canadian growth is forecast at 1.6%, U.S. growth forecast at 1.0%, Eurozone, 1.0%, China at 5.8%
Canadian equity market returns are forecast to be 3.5%-5.5%, annualized over the next ten years
Canadian fixed income returns are likely to be 1.5%-2.5%, annualized over the next ten years.
Vanguard says global central banks have moved from expected policy tightening heading into 2019 to additional policy stimulus amid weakening growth outlooks and inflation shortfalls this year. It expects the US federal reserve to cut the federal funds rate by 25 to 20 basis points before the end of 2020. However, it expects the Bank of Canada to keep interest rates at current levels throughout 2020. While Canadian growth is stable, rising household debt levels and high exposure to global economic uncertainty “skew the balance of risks to the downside.” Schlanger advises Canadian investors to prepare for volatility over lack of trade clarity and slowing economic growth in the U.S. by maintaining diversified portfolios, keeping investment costs low and focusing on the long term while tuning out the daily noise.
Global stocks still have more performance potential than global bonds
Meanwhile, Franklin Templeton believes global stocks have “greater performance potential than global bonds, supported by continued global growth.” Over the next seven years it forecasts strong return potential for both bonds and equities in Emerging Markets. And with short-term interest rates below historical averages, “we see a lower performance potential for government bonds.”
William Yun, Franklin Templeton Multi-asset Solutions
Franklin Templeton recommends a multi-asset approach to deal with an environment of desyncronized global growth and moderate inflation worldwide.
Bill Yun, executive vice president and investment strategist for Franklin Templeton Multi-Asset Solutions (pictured left) said the firm’s 7-year outlook for Canadian bonds the next 7 years is about 1.8% a year, versus 4.8% the past 20 years. Equity return expectations are all positive but reduced from the performance of the prior 20 years: 6% going forward for Canadian equities, versus a historical 7.2%; 6.1% for US equities compared to 6.2% the previous two decades; International equities are projected to return 5.9% versus an historic 4.1%; Emerging Markets 7.1 versus 9% historic, and hedge funds 5.75 compared to 6.4% in the past.
Global central banks have little ammo left
One positive for Canada is that the Bank of Canada has more room to cut rates to cope with an economic slowdown than most central banks in the rest of the world. Canada and the US both have room to cut but Europe does not, Yun said. Some rates are negative in parts of Europe. Continue Reading…
The objective for most investors is to earn value-added performance. Unfortunately there are fees and other costs that can diminish investment returns. The reality is that the costs associated with investing in these products can lead to underperformance when measured against industry standard benchmarks.
The above chart shows the average annual fees and their impact on investment performance for Equity Mutual Funds, Exchange Traded Funds (ETFs), robo-advisors and Transcend’s Pay-for-Performance™ model. This is illustrated by comparing their returns against a benchmark. The benchmark is a universally accepted representation of a particular stock market that is used to measure the performance of a portfolio manager. For example, a benchmark for Canadian equities is the S&P/TSX and a benchmark for U.S. equities is the S&P 500.
Ultimately, excessive fees reduce clients’ investment performance and hampers their ability to reach their financial goals.
While ETFs and robo-advisors are gaining in popularity, mutual funds are still the prevalent investment product for retail investors despite numerous studies that have confirmed the weak investment returns of equity mutual funds relative to their benchmarks. In Canada, a fairly new approach developed by S&P Dow Jones Indices called the SPIVA Canada Scorecard confirms performance failings. The latest result based upon five years of data ending December 2016 confirms that equity mutual funds have underperformed their benchmark, often because fees have such a negative impact on the overall portfolio results.
Mutual funds can charge management fees as well as administrative costs and custodial fees. They can also charge clients for trading, legal, audit and other operational expenses. In the chart above, these fees plus investment related underperformance add up to the average true cost (-2.37%) of investing during the last five years for equity mutual funds.
Even low-cost ETFs, which are designed to mirror a benchmark, tend to disappoint. The performance lag can be tied to the level of fees of 0.32%, plus trading and rebalancing costs as well as a potential cash balancing drag of up to 0.42%, based on 2015 data from the Management Reports of Fund Performance (MRFP) found on the SEDAR.ca website. This analysis does not include the negative impact of brokerage costs to buy and sell, and potential custodian or registration fees. With that in mind, the chart reveals that ETF investors underperform the market appropriate benchmark by -0.74%.
Robo-advisors to the rescue?
Another relatively new entrant to the low cost investment marketplace is the robo-advisor. Employing several common assumptions such as an average portfolio size of $50,000 and trading costs of 0.2% per year, it can be determined that the average robo-advisor fee in Canada is 0.63%.
This cost shows that it is more efficient than traditional wealth management fees, but still lags behind the Pay-for-Performance™ model. While everyone is talking about robo-advisors, the true question should be about getting value for your money and how much fees can impact actual outcomes. Continue Reading…
Stock market investors face a difficult challenge. While long-term stock market returns are quite attractive, in the short-term returns can be quite volatile.
This volatility can be difficult to stomach at times, especially when accompanied by worrying news flow.
Adding to the angst for Canadian investors can be the volatility of the Canadian dollar, yet it makes sense for Canadians to diversify globally. It is important from time to time to review the historical evidence to help us manage our behaviour and stick with our investment plans. Let’s review some of the long-term evidence:
Evidence*
“Long-term stock markets returns are quite attractive”
The average annual return of the S&P/TSX Composite index of Canadian stocks over the 60 years between 1957 and 2016 is 9.1%
The average annual return of the S&P500 index of large cap US stocks over the 91 years between 1926 and 2016 is 10%
The average annual return of the MSCI EAFE index of developed market stocks outside North America over the 47 years between 1970 and 2016 is 9.1%
Exposure to small-company stocks and low-valuation stocks has led to higher performance levels than that of market capitalization weighted indices over long periods of time
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