Ja­son Heath breaks down the top fac­tors that af­fect fi­nan­cial plan­ning de­ci­sions.

Calgary Herald - - FINANCIAL POST - Ja­son Heath is a fee-only, ad­vice-only Cer­ti­fied Fi­nan­cial Plan­ner (CFP) at Ob­jec­tive Fi­nan­cial Part­ners Inc. in Toronto. He does not sell any fi­nan­cial prod­ucts what­so­ever.

Re­cent stock mar­ket volatil­ity has put a spot­light on daily mar­ket move­ments for peo­ple who would not nor­mally pay such close at­ten­tion to their port­fo­lio. Set­ting ap­pro­pri­ate ex­pec­ta­tions about in­vest­ment re­turns is im­por­tant for in­vestors and ad­vis­ers. These ex­pec­ta­tions de­pend on sev­eral fac­tors and af­fect in­vest­ment and fi­nan­cial plan­ning de­ci­sions.


Most peo­ple in the in­vest­ment in­dus­try use trea­sury bills or govern­ment bonds as a proxy for a risk-free rate of re­turn. How­ever, most av­er­age in­vestors would con­sider a Guar­an­teed In­vest­ment Cer­tifi­cate (GIC) to be a more ap­pro­pri­ate bench­mark.

GIC rates are cur­rently in the 2.5-per-cent range for one- to five-year terms. This is un­usual, as longer-term GICS usu­ally pay higher in­ter­est rates than shorter-term ones. The yield curve is cur­rently “flat.” In order to se­cure rates of 2.5 per cent, you need to look past the banks to trust com­pa­nies and credit unions, as the banks are only pay­ing be­tween 1.5 and two per cent.

The FTSE Canada Uni­verse Bond In­dex is a good bench­mark for midterm Cana­dian in­vest­ment grade bonds, in­clud­ing govern­ment and high-qual­ity cor­po­rate bonds. The cur­rent yield to ma­tu­rity (in­ter­est rate) is only 1.5 per cent.

The dis­tri­bu­tion yield (div­i­dend rate) for the S&P/TSX Capped Com­pos­ite In­dex is cur­rently 3.6 per cent, and for the S&P 500, it is 2.4 per cent. These yields as­sume the un­der­ly­ing com­pa­nies con­tinue to pay the same div­i­dends in the next year as they did in the past year, which may be ques­tion­able given the cur­rent state of the econ­omy.

Higher yield­ing bonds are avail­able for in­vestors will­ing to take on more risk. Higher yield­ing stocks with larger div­i­dends are avail­able as well, al­beit po­ten­tially at the ex­pense of po­ten­tial cap­i­tal growth oth­er­wise re­served for com­pa­nies that may pay lower or no div­i­dends.

Stock mar­ket in­vestors ex­pect to earn a re­turn by way of cap­i­tal ap­pre­ci­a­tion or an in­crease in the un­der­ly­ing price of stocks. Stock mar­kets gen­er­ally rise over time, although that rise is not in a straight line, as we have seen un­der­scored in 2020.


Stocks rise in value about three out of ev­ery four years. They typ­i­cally do not fall in value in con­sec­u­tive years as re­ces­sions tend to be short lived. Over the past 100 years, the S&P 500 has only had four multi-year de­clines, in­clud­ing four straight years at the out­set of the Great De­pres­sion, three straight years at the start of the First World War, two years in a row dur­ing the 1973 oil cri­sis, and three con­sec­u­tive years fol­low­ing the burst­ing of the tech bub­ble in 2000.

A bal­anced port­fo­lio of stocks and bonds has not had a neg­a­tive five-year re­turn since 1935. As a re­sult, a bal­anced in­vestor with a time hori­zon of more than five years can prob­a­bly ex­pect to have a higher port­fo­lio value than now by that time.

Over the past 50 years, the TSX has re­turned 9.1 per cent an­nu­ally. The S&P 500 has re­turned 11 per cent in Cana­dian dol­lar terms. Cana­dian in­fla­tion over the past 50 years has been 3.9 per cent, so this means part of those re­turns are re­flec­tive of higher an­nual cost of liv­ing in­creases in the past than we are used to to­day. The Bank of Canada and most cen­tral banks have a two-per-cent in­fla­tion tar­get.

Over the past 20 years, go­ing back to the peaks of the 2000 dot-com bub­ble, Cana­dian stocks have only re­turned 6.3 per cent, and U.S. stocks, in Cana­dian dol­lars, only 5.4 per cent.

His­tor­i­cal bond re­turns are some­what skewed be­cause in­ter­est rates were so much higher in the past. Cana­dian three-month trea­sury bills — the afore­men­tioned proxy for a Cana­dian risk-free rate — re­turned 5.6 per cent over the past 50 years, but just two per cent over the past 20 years. Given the three-month trea­sury bill yield is cur­rently 0.27 per cent, this re­in­forces why some as­pects of in­vest­ment his­tory can re­sult in de­ceiv­ing ex­pec­ta­tions for the fu­ture.


FP Canada is the pro­fes­sional body for Cer­ti­fied Fi­nan­cial Plan­ners (CFPS) in Canada. Their 2020 Pro­jec­tion As­sump­tion Guide­lines found the av­er­age long-term re­turn as­sump­tions from 11 ac­tu­ar­ial and as­set man­age­ment firms for bonds was 3.15 per cent. Cana­dian stocks, for­eign de­vel­oped mar­ket stocks (like the U.S.), and emerg­ing mar­ket stocks (most no­tably China) were fore­cast at 6.05 per cent, 6.25 per cent, and 8.02 per cent, re­spec­tively.

The lat­est tri­en­nial Ac­tu­ar­ial Re­port on the Canada Pen­sion Plan from Dec. 31, 2018 in­cluded govern­ment es­ti­mates for stock mar­ket re­turns. They an­tic­i­pated a “real” rate of re­turn for pub­lic eq­ui­ties of 3.9 per cent un­til 2025 due to low cash re­turns. By 2025, their fore­cast was 4.3 per cent. In a two-per-cent in­fla­tion en­vi­ron­ment, these real re­turns sug­gest a nom­i­nal 5.9 to 6.3 per cent per year over­all for stocks, with higher re­turn po­ten­tial iden­ti­fied for emerg­ing mar­kets and pri­vate eq­ui­ties.

There are other meth­ods to try to fore­cast fu­ture stock mar­ket re­turns, per­haps most no­tably from Yale econ­o­mist and No­bel Prize win­ner, Robert Shiller. The Shiller P/E, or cycli­cally ad­justed price-earn­ings (CAPE) ra­tio, is a sta­tis­ti­cal method used to im­ply fu­ture stock mar­ket re­turns.

It is determined by di­vid­ing the price of a stock or a stock mar­ket, like the S&P 500, by the av­er­age of the pre­vi­ous 10 years of in­fla­tion-ad­justed cor­po­rate earn­ings.

A lower CAPE sug­gests that stock prices are cheap rel­a­tive to his­tor­i­cal earn­ings. A high CAPE — as we have right now in the U.S. — im­plies stocks are over­val­ued and fu­ture re­turn ex­pec­ta­tions are low.

The Shiller P/E ra­tio has its crit­i­cisms, some of which sug­gest to­day’s CAPE can­not be com­pared to his­tor­i­cal ra­tios due to low in­ter­est rates, dif­fer­ent busi­ness and reg­u­la­tory con­di­tions, and changes in ac­count­ing meth­ods.


So, what does all this mean for in­vestors and ad­vis­ers? One take-away should be that fu­ture stock mar­ket re­turns could be lower than they have been in the past. This prog­nos­ti­ca­tion has nothing to do with the pan­demic or try­ing to make a call on what stocks will do for the bal­ance of 2020. It has more to do with the fact that to­day’s low in­ter­est rates and in­fla­tion sug­gest fu­ture re­turns must be lower.

Long-term stock mar­ket re­turns of six to seven per cent are prob­a­bly rea­son­able for most pub­lic stock mar­ket in­vestors, and po­ten­tially seven to eight per cent for pri­vate eq­ui­ties and pub­lic emerg­ing mar­kets.

Most in­vestors will not earn six to eight per cent sim­ply be­cause of fees and fixed-in­come ex­po­sure. In­vestors can­not in­vest for free, can­not con­sis­tently beat the mar­ket net of fees, and few in­vestors are ex­clu­sively in­vested in stocks.

Ad­vis­ers should be con­tin­u­ously mon­i­tor­ing an in­vestor’s risk tol­er­ance, us­ing the pan­demic volatil­ity as a barometer for how much risk an in­vestor is truly will­ing to take.

For pur­poses of re­tire­ment plan­ning, long-term re­turns of three to six per cent as a range may be ap­pro­pri­ate as­sum­ing a two-per-cent in­fla­tion rate, de­pend­ing on as­set al­lo­ca­tion and fees, and con­tin­gent on whether a re­tire­ment plan in­cludes a Monte Carlo sim­u­la­tion or stress test­ing.

Ap­pro­pri­ate ex­pec­ta­tions about in­vest­ment re­turns from year to year and over an in­vestor’s life­time can help im­prove short and long-term in­vest­ment out­comes. De­vel­op­ing a fi­nan­cial plan based on those ex­pec­ta­tions can help set monthly sav­ing and spend­ing tar­gets, eval­u­ate in­surance needs, de­ter­mine tax and es­tate strategies, and keep an in­vestor in­vested when the go­ing gets tough.


Stock mar­ket in­vestors should ex­pect to earn a re­turn by way of cap­i­tal ap­pre­ci­a­tion or an in­crease in the un­der­ly­ing price of stocks, although that rise is not in a straight line, as we have seen un­der­scored in 2020, Ja­son Heath says.

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