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portfolio strategy

It's time to reset your investment assumptions Add to ...

Let’s get real about investment returns.

Adviser John De Goey did just that recently and he’s now using a lower long-term rate of return when he builds portfolios for clients. Mr. De Goey has long been using Andex charts, a recognized investment industry source owned by Morningstar, to develop his return expectations. Going back to 1950, he said, the charts showed average annual stock market returns of 10.3 per cent in Canada over the past 60 years and 11 per cent annual gains in the U.S. market.

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Then Mr. De Goey attended a pair of investment industry conferences recently. At the first, he learned that Canadian stock market returns are somewhat lower on average if you go back to the Great Depression. At the second, he heard four senior portfolio managers say they target real returns of just 4 per cent (after inflation). Upon his return to the office, he decided to reset his return expectations.

“I came to the realization that, in spite of my very best efforts, the assumptions I’ve been using are unduly optimistic,” said Mr. De Goey, vice-president and associate portfolio manager at Burgeonvest-Bick Securities.

We should check our investment assumptions right now. It has been five years since the global financial crisis began and there’s no sign yet the stock market will once again be a reliable generator of double-digit investment gains. But what’s a realistic assumption at a time when stocks are up and down, and bonds typically offer returns in the sub-2 per cent range?

Mr. De Goey now uses a long-term real return of 4 per cent, or 6 per cent before an expected inflation rate of 2 per cent. As you’ll see in the following survey of investment industry people, that’s right in line with current thinking on returns in the 10 years to come.

The survey asked a dozen experts to estimate rates of return for the 10 years ahead on a diversified portfolio (60 per cent in stocks and 40 per cent in bonds), and to estimate the inflation rate over that period. For additional perspective, I invited my Twitter followers (my Twitter handle is rcarrick) to participate in an online survey that is summarized below.

Here’s how to use the data below:

-Step 1: Subtract the inflation rate from the estimated portfolio gain to get the real rate of return, which is the most meaningful gauge of performance.

-Step 2: Subtract any fees charged by the investments you own and, if applicable, your adviser’s. If you’re a do-it-yourself adviser using exchange-traded funds, you might realistically lower your portfolio return by 0.5 to 0.75 of a percentage point. If you use mainstream mutual funds sold by an adviser, reducing your returns by 2 per cent makes sense.

-Step 3: Remember that taxes will reduce your final returns to a varying extent.

Follow on Twitter: @rcarrick

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