In my column two weeks ago, I said people can save thousands of dollars a year by giving up car ownership. I also provided an example of how much those savings would grow if they were invested at a hypothetical return of 8 per cent annually.
Well, it wasn't long before the critical comments started pouring in.
"Please tell me how you think you'll average an 8-per-cent pretax return in this environment," one reader posted online.
"You are a genius! If I send you $7,000, will you please invest it for me at 8 per cent for 10 years?" another reader asked in an e-mail.
Well, first I should point out that I made a boo-boo in my calculations. Investing $7,000 a year for 10 years at a pretax return of 8 per cent would produce a sum of about $110,000, not $156,000 as I incorrectly reported. Evidently, I made an error when entering numbers into my online compound interest calculator.
But readers weren't questioning my math. They were questioning my assumption that one could realistically earn an 8-per-cent return.
So today we're going to put that assumption under the microscope.
If you're investing in bonds or guaranteed investment certificates, then, no, an 8-per-cent return is not realistic. The 10-year Government of Canada bond currently yields about 1.3 per cent and you'd be lucky to get 2.5 per cent on a five-year GIC. Unless you're buying speculative corporate bonds, you won't get anything close to an 8-per-cent yield on a fixed-income security.
What about stocks?
The first reader was skeptical that an 8-per-cent return is achievable "in this environment." I'm not sure what the reader was referring to specifically – low interest rates? low commodity prices? market volatility? all of the above? – but I've heard this sort of comment before. No matter what's happening in financial markets or geopolitically at any given time, some investors will focus on the negatives to justify a pessimistic outlook for stocks.
But as the old saying goes, markets often "climb a wall of worry." I've been managing my Strategy Lab model dividend portfolio since September, 2012 – a period that has seen plenty of upheaval – and it has been performing just fine. My total return through April 30 was 45.4 per cent (all return figures include dividends), or about 10.8 per cent on an annualized basis. That's nearly three percentage points better than the 8-per-cent return assumption some readers consider unrealistic. (View my model portfolio online at tgam.ca/divportfolio.)
One can't generalize based on the performance of a single portfolio over a period of less than four years, so let's look at how the stock market has performed over longer time frames. We'll focus on the U.S. market because there are more data available.
For the 20 years ended Dec. 31, 2015, the S&P 500 posted a total compound annual growth rate of about 8.2 per cent. That period, it's worth mentioning, included two massive bear markets – the technology meltdown of 2000-02 and the financial crisis of 2008-09. Even with those major setbacks, the S&P 500 still exceeded the 8-per-cent annual return that I used in my example.
Twenty years not long enough for you? Over the past 50 years, the S&P 500's compound annual growth rate was even better, at 9.7 per cent. (I used the S&P 500 return calculator at moneychimp.com/features/market_cagr.htm.) Based on that performance, an 8-per-cent return assumption would seem reasonable.
The returns mentioned above don't take inflation into account. The inflation-adjusted – or real – return of the S&P 500 over the past half-century was about 5.4 per cent.
What about Canada? According to the 2016 Credit Suisse Globe Investment Returns Yearbook, Canadian stocks have delivered a real return of 5.6 per cent a year since 1900, which is close to the 6.4-per-cent real return of U.S. stocks over the same 116-year period. The latter figure, incidentally, is similar to the real return of 6.6 per cent for U.S. stocks from 1802 to 2012, as quoted in Jeremy Siegel's book, Stocks for the Long Run.
From year to year, of course, stock market returns vary widely. Instead of rising smoothly, the market has some good years, some great years and some lousy years. If you want to achieve the market's long-term returns, you have to be prepared to endure some depressing – and occasionally downright scary – periods that may last months or years. Unfortunately, many investors do not earn anything close market returns because they sell when times get tough and buy when euphoria takes over and the rebound has already occurred.
Nobody knows what the stock market will do in the years ahead, but it has been making investors wealthy for a long time and I expect that to continue. While it's true that past performance is no guarantee of future returns, I think it's reasonable to expect high single-digit percentage returns to continue, with something closer to mid-single-digit returns after inflation.
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