Look long term when setting goals on return

Historical financial information on individual stocks and indices always show returns are unpredictable.

The last decade of annual returns from the TSX/S&P Composite Index range from a loss of 35 per cent to a gain of 31 per cent.

It can be a challenge to set return expectations with so much volatility in the short term.  Financial plans map out expected returns over a longer period of time.

When we begin working with a client we feel it is important to set reasonable expectations at the beginning of the relationship.  No advisor can guarantee returns on an investment portfolio.

It is reasonable that in some years your portfolio will do well and in other years your portfolio will have a negative return.  With increased volatility, projecting returns for financial planning has become more difficult.  Everyone would like clarity on whether they will reach their future financial goals.

A great question to discuss is what you feel is a reasonable return for your long-term financial plan.  This may be a tough question to answer during an introduction meeting, especially if risk tolerance and investment objectives are not known.

The first step we use to estimate returns is to look at asset mix, the percentage you would like to have in cash equivalents (savings accounts), fixed income (bonds, GICs, debentures, coupons, etc.), and equities.  The second step is to determine the types of equities you are interested in (low, medium, or high risk).  The third step is to set reasonable percentage returns for each category.  As an example we have outlined below some investment categories with projected returns.                     

Category Projected Return %
Cash Equivalents

1.5

Fixed Income

4.5

Equities (low risk)

6.0

Equities (medium risk)

7.0

Equities (high risk)

8.0

The above projected returns for cash and fixed income are easier to determine in the short term.  Projected equity returns are based on longer term historical performance but should also factor in current and projected future conditions.  Cash equivalents and fixed income are on the low side currently because interest rates are low.  Equity returns, as well, are on the lower side of historical averages given current economic conditions.  It’s also important to note that these are only projected and therefore, not guaranteed.

The fourth step is to map out what type of investment portfolio is most suitable for you.  Below we have outlined five options with projected long term returns, investment objectives, risk tolerance, expected volatility and a description of typical holdings.

Option 1:  Asset Mix: 25 per cent cash, 75 per cent fixed income.  Projected return is:  3.75 per cent [(25% x 1.5%) + (75% x 4.5%)].  Primary investment objective:  capital preservation.  Risk profile:  low.   Expected volatility:  positive returns every year.  Description:  holdings would be primarily Canadian money market investments, savings accounts, GICs, and bonds.  Investor Profile:  preservation of capital is primary goal and you would sacrifice some income and return potential to protect existing capital.

Option 2:  Asset Mix:  75 per cent fixed income, 25 per cent low risk equities.  Projected return is:  4.88 per cent [(75 per cent x 4.5 per cent) + (25 per cent x 6.0 per cent)].  Primary investment objective:  income.  Risk profile:  low to medium.  Expected volatility:  low to medium volatility, such as negative returns one in every eight years.  Description:  holdings would be primarily GICs, bonds, preferred shares, and lower risk common shares.  Investor Profile:  the provision of a steady income through interest and dividends is of primary importance, rather than growth of income or capital preservation.

Option 3:  Asset Mix:  25 per cent fixed income, 75 per cent medium risk equities.  Projected return is:  7.13 per cent [(25per cent x 4.5 per cent) + (75 per cent x 8.0 per cent)].  Primary investment objective:  growth and income.  Risk profile:  medium.  Expected volatility:  medium volatility, such as negative returns one in every six years.  Description:  holdings would be primarily corporate bonds, preferred shares, and low to medium risk common shares.  Investor Profile:  income requirements are low and the emphasis is on total portfolio return from both capital appreciation and income.

Option 4: Asset Mix: 100 per cent medium risk equities.  Projected return is:  7.0 per cent [(100 per cent x 7.0 per cent)].  Primary investment objective:  moderate growth.  Risk profile:  medium to high.  Expected volatility:  medium to high volatility, such as negative returns one in every five years.  Description:  holdings would be primarily Canadian, US, and international blue chip equities.  Investor Profile:  primary objective is growth of capital.

Option 5:  Asset Mix:   100 per cent high risk equities.  Projected return is:  8.0 per cent (100 per cent x 8.0 per cent)].  Primary investment objectivemaximum growth.  Risk profile:  high.  Expected volatility:  high volatility, such as negative returns one in every four years.  Description:  holdings would be primarily higher risk equities, including precious metals, small capitalization stocks, and emerging markets.  Investor Profile:  goal is to generate maximum long-term capital growth.

The above options highlight that equities typically outperform cash and fixed income in the long term; however, investors who venture into equities have to deal with increased volatility.  From a financial planning perspective, estimating investment returns is more challenging as you increase the equity component.