Skip to main content
//empty //empty

Dan Richards is president of Clientinsights. He is a faculty member in the MBA program at the Rotman School at the University of Toronto.

Of all the assumptions that go into a retirement plan, none has a bigger effect than the return you expect to get on your investments. That number determines how much you need to save, when you can afford to retire and the kind of lifestyle you can plan for.

Over the very long term, stocks have averaged a return of about 10 per cent a year. In the last while, many industry insiders have suggested that it would be wildly optimistic to expect this kind of return in the future.

Story continues below advertisement

Indeed, a Wall Street Journal article last week indicated that the giant California Public Employees Retirement System (Calpers) pension plan in California is reducing the assumed return on its total portfolio of stocks, bonds and other investments.



More on retirement and pensions:

  • How not to outlive your money
  • Annuities: An option for any retiree
  • You won't live forever, so read this
  • Seven tools for rebuilding retirement savings


When it comes to your return assumptions, there are costs to being both too optimistic and overly conservative. Obviously, overly rosy assumptions can lead to disappointment as people fall short of their goals. But there's a price for being too conservative as well - since overly pessimistic assumptions could lead Canadians to make poor decisions about investing. After all, if you think you're only going to get 2 per cent on stocks, why not just buy guaranteed investment certificates?

Two key decisions

To think intelligently about expected returns, you need to make two key decisions.

First, shift your thinking to after-inflation returns - what the industry calls real returns. This way, you'll focus on spending power - what really counts in retirement. Indeed, this is what sophisticated pension plans and high-net-worth investors are already focusing on.

Second, you have to extend your time frame. The shorter your time frame, the more uncertainty you'll experience on returns - pick one year as your time horizon and you could experience swings of 40 per cent in either direction.

Even five- and 10-year periods can subject you to substantial swings in returns on stocks, especially if you do what many investors do and set your expectations based on what happened in the last three to five years.

Story continues below advertisement

The only way to bring stability to your expected returns is to follow pension funds and high-net-worth investors and look out 15 or 20 years. That may seem an unduly long time frame, but in fact, that's the horizon that most Canadians need to think about. Even if you're a 65-year-old couple, there's a 50-per-cent chance one of you will live to age 90.

Looking inside average returns

The third key decision for investors is to look beyond averages.

There is good data on stock market returns in the United States going back to 1926. In the 85 years since then, after-inflation returns have averaged 6.6 per cent.

The big difficulty with an average number is that often you'll be below it. Given the high cost of underperforming your return assumption, you need to look beyond the average return to the distribution of returns that got you to that average - that will tell you how badly you might fall short based on historical precedent.

Recently, I spent some time with Michael Nairne and his team at Tacita Capital, looking at long-run total returns (including both capital appreciation and dividends) on the Standard & Poor's 500-stock index.

Story continues below advertisement

Since 1926, there have been 65 20-year periods. If we list the real returns during those 65 periods from highest to lowest and look at how often those returns happened, here's what you end up with.

Annual return after inflation in 65 20-year periods - 1926 to 2009:

Return

% of the time this happened

13.3 %

1 %

12.7 %

5 %

11.9 %

10 %

10.8 %

20 %

9.3 %

33 %

8.5 %

50 %

5.0 %

67 %

3.3 %

80 %

2.2 %

90 %

1.8 %

95 %

0.8 %

100 %

Picking your number

In deciding on the expected return for the stock component of your savings, you could pick the after-inflation return that's halfway down the list; that would give you a return of 8.5 per cent, but risks erring on the optimistic side. For those who want to be more conservative, you should choose one of the lower numbers - the 5 per cent that was achieved two-thirds of the time or the 3.3 per cent that was exceeded 80 per cent of the time. Or you could be really cautious and pick the 1.8 per cent that was delivered 95 per cent of the time, in 62 out of 65 20-year periods.

Of note, the worst after-inflation returns all occurred during the high-inflation years in the 1970s. As a result, your assumption about the return on the stock component of your savings will be heavily influenced by the concern about a return to inflation. Picking the right return assumption for your investments will vary with your attitude toward risk. By focusing on after-tax returns, taking a long-term view and digging deep into the historical experience, you can end up with a realistic number that strikes the right balance between undue optimism and extreme pessimism.

Report an error Editorial code of conduct
Due to technical reasons, we have temporarily removed commenting from our articles. We hope to have this fixed soon. Thank you for your patience. If you are looking to give feedback on our new site, please send it along to feedback@globeandmail.com. If you want to write a letter to the editor, please forward to letters@globeandmail.com.

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff. Non-subscribers can read and sort comments but will not be able to engage with them in any way. Click here to subscribe.

If you would like to write a letter to the editor, please forward it to letters@globeandmail.com. Readers can also interact with The Globe on Facebook and Twitter .

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff. Non-subscribers can read and sort comments but will not be able to engage with them in any way. Click here to subscribe.

If you would like to write a letter to the editor, please forward it to letters@globeandmail.com. Readers can also interact with The Globe on Facebook and Twitter .

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff.

We aim to create a safe and valuable space for discussion and debate. That means:

  • Treat others as you wish to be treated
  • Criticize ideas, not people
  • Stay on topic
  • Avoid the use of toxic and offensive language
  • Flag bad behaviour

Comments that violate our community guidelines will be removed.

Read our community guidelines here

Discussion loading ...

To view this site properly, enable cookies in your browser. Read our privacy policy to learn more.
How to enable cookies