By Rob Carrick. Originally published by the Globe and Mail on May 19, 2015. Republished with permission.
Though designed for people in the financial industry, DIY investors and adviser clients have much to gain from some new documents
Some of the country's top financial minds think you should expect to make 6.3-percent a year in Canadian stocks over the long term and 3.9 per cent in bonds.
You'll find these numbers in a new document created by a pair of financial planning organizations as a reference for planners and advisers. The investment industry works hard to maintain an aura of expertise in matters such as estimating returns, but the truth is that this process can be subject to personal biases and agendas. For example, an adviser might try to wow a new client by insisting big returns are possible.
The new Projection Assumption Guidelines (download the document) aim to standardize and professionalize the planning process by providing the latest and best thinking on returns, inflation, interest rates and life expectancy. "Canadians benefit from objective assumptions, and they also benefit from a standardization of assumptions across the industry - firms and planners," said Joan Yudelson, vice-president of professional practice at the Financial Planning Standards Council, which produced the guidelines in collaboration with the Institut québécois de planification financière. Both the IQPF and the FPSC set standards for financial planners - the IQPF in Quebec, and the FPSC by overseeing the certified financial planner (CFP) designation. The IQPF has been producing the guidelines since 2009 and recently joined forces with the FPSC.
The guidelines are designed for people in the financial industry, but they're worth a look from both DIY investors and adviser clients. You'll better manage your own money and work more effectively with your adviser if you're well informed about things like expected future stock and bond returns.
Let's be clear about the guidelines - they're educated projections that will be refined over time, and not a forecast of what's just ahead. Think of them as a summation of analysis by the Canada and Quebec pension plans, surveys of portfolio managers by pension consulting firms and long-term historical returns.
Whether you're a financial planner or a DIY investor, these are legitimate numbers on which to build your analysis.
The return expectations are what will interest individual investors most and they're full of surprises on both stocks and bonds. Canadian stocks are expected to produce total returns of 6.3 per cent before fees (share price changes plus dividends), quite the comedown from the average 9- per-cent gains over the past 30 calendar years.
One of the top investing questions right now is whether we are entering a period of diminished investment returns. The Projection Assumption Guidelines on stocks support that. In fact, there has been a steady reduction in return expectations for Canadian stocks since the IQPF began to produce these guidelines in 2009.
Back then, stocks were thought to be on track for annual gains of 7.25 per cent.
The most controversial aspect of the guidelines could be the data on bond returns. You know how a lot of market watchers can't stop talking about a bear market for bonds arriving when interest rates start to move higher? The guidelines appear to disagree. They call for total returns of 3.9 per cent (interest plus changes in bond prices), which is roughly half the 30-year average, but still surprisingly good.
William Jack, an actuary and CFP who worked on the guidelines, said the bond returns should be viewed as long-term projections that look beyond the next couple of years. "The really important thing to remember is that these rates are going to be used for projections that can stretch out 25, 35 or 45 years," he said.
The return projections don't make a specific call on global equities, but there's a note saying that you can either use the same number as for Canadian equities or add as much as one percentage point to that number. No accounting was made for currency fluctuations, on the basis that our dollar's ups and downs versus the U.S. dollar and other global currencies net out to zero over the long term.
Wondering about the role of dividends? The guidelines say that historically, 25 to 50 per cent of returns have come from dividends. A decision to split the difference was made so that dividends are projected to account for 33 per cent of stock market returns, with the rest coming from capital gains.
Financial planner Rona Birenbaum says the value of the guidelines is that they bring consistency to a business whose return expectations can vary widely. "We're on the low end - we project at 4 per cent [for portfolios]," she said. "But I've seen projections in the last few years somewhere between 5 and 7 per cent, although we don't see 7 too much any more."
These projections are crucial for getting the right results from financial planning. Lower returns put more onus on investors to save for retirement, and to be cautious about spending after leaving the work force. Preferring to give clients "good news" on saving and spending, advisers may use overly optimistic return projections.
It's no surprise, then, that early feedback on the guidelines suggests advisers and planners see the expected returns as being too low. "One individual said that he didn't think any of his financial plans would work with the returns we recommended," Mr. Jack said.
The guidelines present returns on a before-fee basis, while also suggesting that the cost of advice and investments can easily range from 0.5 per cent to 2.5 per cent.
In some examples of how to use the guidelines, overall fees for a balanced portfolio come in at 1.8 per cent. With 5 per cent in cash, 45 per cent in bonds and 50 per cent stocks, this portfolio would have an after-fee return of 3.3 per cent.
The guidelines are useful in a practical sense, but they're also a sign of an evolving professionalism in the financial planning world. The IQPF and FPSC have already issued new national standards for planners that, for example, set out what terms such as "financial planner" and "financial plan" actually mean. Anything that takes the salesmanship out of financial planning and substitutes expertise is a plus.