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Rates of return and the end game

Monday Januray 21, 2013

I think with the very low interest rate world we are currently in, investors can look at fixed-income rates of return in the 1%-5% range and perhaps 4%-8% for most equities going forward. If you have a mix of fixed income and equities in your portfolio, a 6% overall rate of return is a reasonable expectation. Yes, I know that seems a “low” rate of return (ROR). After all, you’ve probably read of some investors making the “big score,” or you’ve heard a friend or acquaintance boast about their astounding rate of return over the previous year. But this is a dangerous game to play, and I’ll explain why.

The consensus now is that we are in an extended era of low interest rates, with a consequent expectation of lower returns in equities too. I think the days of looking for 8%-10% growth over the long term is gone, or at the least is an unrealistic expectation. The U.S., Europe, and Japan, which 10 years ago comprised most of the world’s economic output are slowing, because of both debt and demographic shifts, and this won’t change anytime soon. Realistically, expected rates of return are going to be lower than they were a decade ago.

Too focused on rate of return

But what do I mean by “Rates of return (ROR) and the end game”? I think far too many investors are too focused on ROR. What did I make this year? What have I made since I started five years ago? While those are reasonable questions, they bypass the really important questions, which are these: “Am I on track with my retirement goals” and “Will I have enough money in retirement to do the things I want?”
When we first start investing, our goal is not to make 5% or 8% per year over the long term. Our goal is to save money to educate our children, save for a comfortable retirement, or reduce the income taxes we pay. Once we become seasoned investors and became more educated about investing, however, we often get sidetracked by ROR and sometimes make poor decisions as a result of it.

There will be years where the investment returns are poor. That is a fact of life. We are currently in a bad stretch, where ROR has been mediocre for about 12 years. We obviously can’t control the markets or our ROR, so what can we do? We can worry less about markets and ROR and focus on our goals.

I have seen clients with ROR of only 4%-5%, but because they kept adding money every month, their account went from $100,000 at the start of the year to $120,000 at the end of the year. That’s an additional $20,000 that will help the clients come retirement time. If in mediocre markets you can keep your bottom line going in the right direction, then if we have a really good year, all the better. But we don’t get too worried if that doesn’t happen, because it’s uncontrollable. Just keep making small adjustments to ensure you are moving ever forward and doing the simple things right. Investing on a monthly basis, making a lump sum buy on market dips to take advantage of lower pricing, and taking advantage of free money (RRSPs and RESPs).

I have seen people move from a trusted advisor who was making them money and transfer everything to an unknown advisor at the suggestion of a friend who happened to earn more during a period of time. They subsequently lost 40% over the next year. Why did the friend make more money? It’s a result of having different goals, different risk tolerance, different time horizon, and so on. But they went ahead and blindly bought the same investments as their friend, losing a trusted financial advisor in the process. Why did they make the move? Impatience and focusing on the ROR instead of the end game (the goals and/or plan). This is a recipe for disaster. They also run the additional risk of the new financial advisor being unscrupulous, doubling the chance for failure.

Concentrate on your end game

When you meet with your financial advisor in the months and years ahead, try and focus on your goals, not the ROR. You can hope to bump up your ROR by shifting fixed income to equities (especially natural resources, precious metals, and emerging markets), but remember that you are assuming additional risk too in search of a higher ROR. Are you moving in the right direction? Are you mitigating risk by having a fixed income element in your portfolio? Are you investing monthly to move consistently toward your goals? That should be your focus instead of chasing last year’s winners or copying a friend’s portfolio in hopes that it will work for you.
Always remember your end game. Make sure you keep working towards it with a trusted advisor who has your best interests at heart.

 

 

Generic Mutual Fund Disclaimer

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the simplified prospectus before investing. Mutual funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated.

Personal Opinions & Recommendations Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. However, please call the author to discuss your particular circumstances.


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