I recently attended an investment conference in New York, a city that’s always fun to visit… especially when work can be combined with pleasure. While there we went to see the 9/11-inspired play, “Come from Away”, based upon the true events that transpired in Gander, Newfoundland when dozens of American-bound planes were forced to land there due to the closure of US air-space following the bombing of the twin towers. In a word: “spectacular”. The play was a 10 out of 10 in every respect and I encourage everyone to see it if they have the chance. It’s a totally beautiful story… poignant, funny, great Newfoundland music, wonderful acting.
Back to work… in addition to presentations on the current state of economies around the world, the conference gave a high altitude 360 perspective on the investment universe today. The underlying theme of this perspective was that in today’s investment climate, safely takes precedence over seeking higher returns with added risk. Essentially, the message is that there is a time to be focused on unrestrained growth-oriented investing, and there is a time to be focused on cautious, measured investing. The investment opinion-leaders were unanimous in their belief that we are at a stage in the market cycle where safety must be factored into all investment decisions. This position is underscored by current global economic and geopolitical uncertainties.
Furthermore, with bond yields low and stock valuations high, future returns may be lower than you think.
How low is low? And how long will it last?
Those are the questions for investors to consider as the era of extremely low short-term interest rates continues – even with recent upticks in rates, the long term forecast for bonds is still very low, historically speaking – throwing into doubt long-held assumptions about the returns retirees can expect from their savings. In the developed world, about $7.9 trillion in government bonds will effectively pay a negative yield if they’re held to maturity.
Equities are much less predictable, but there’s reason to anticipate lower equity returns as well. In part because the returns available from bonds are so low, investors have poured money into stocks. The result is that they have pushed up valuations of equities in the years since the Great Recession of 2008. Here’s one simple measure: Stocks on the S&P 500 trade at an average price of 19 times earnings, up from about 10 times in early 2009 when the current bull market began.
Researchers at Morningstar believe that we are in for lower than typical returns for the next 10 years. This may come as an especially rude shock to investors in the US, where stocks have earned an annualized average of about 10 percent over the long term.
Now, having said this, keep in mind that no one has the benefit of seeing into the future… experts can only rely on historical statistics, current and anticipated future economic conditions and patterns – plus experience. Thus, the world’s top investment experts and economists simply make their best projections… and as often as not, they are wrong. But this does not mean we should ignore their thinking. We should include all factors in our considerations when making investment decisions.
A lower baseline for investment returns has consequences for a wide range of financial planning decisions, including how much to save, how much to withdraw in retirement, and where to invest.
It is expected that bonds – including higher-yielding corporate debt – are likely to average 2 percent to 3 percent over the coming decade. A combined global and Canadian stock portfolio might earn about 7-8 percent. Translation: The markets are unlikely to bail you out if you haven’t saved enough.
If so, lower returns will have the most immediate impact on people who are in or near retirement. Financial advisors often cite a rule of thumb that retirees can set annual spending at 4 percent of the value of their nest egg, then raise the dollar amount each year with inflation. Today, a 3.5 percent initial withdrawal might be more realistic, according to many planners. For a retiree with $2 million, switching from 4 percent to 3.5 percent means a $10,000 reduction in yearly income. Some retirees will likely instead respond by allocating more of their portfolios to equities to reach for higher returns.
At the other end of the spectrum, for people turning 30, deflated returns will mean they’ll have to work seven years longer or save almost twice as much to end up with the same nest egg as those born roughly a generation ago, according to a recent report by McKinsey. The prior generation enjoyed what the consulting firm calls a golden era of high returns based on declining inflation and interest rates, swelling corporate profits, and an expanding price-earnings ratio for stocks. Now inflation and rates can hardly get lower, and the other factors seem unlikely to recur.
It is important to bear in mind that most financial planners in Canada typically employ a 6%-7% rate of return (lower for conservative investors) when constructing a retirement plan for their clients. This rate of return may still remain valid for those investors with a long time horizon, however it may be somewhat aggressive for those with short time horizons. This may mitigate the concern for many pre-retirees, however it does not diminish the issue of lower returns generally.
Some of the best strategies to boost returns from here on might be tactical. Make the most of tax-advantaged savings programs such as RSP’s and TFSA’s – and pay close attention to the fees you pay on investments. Minimizing debt will help as well. What you save on interest by paying off a loan may beat the returns you’ll get from equities and bonds.
Not everyone in the market is ready to accept the idea of low returns. Investor denial is actually creating risky behavior in the way that they are putting money to work. In turn, this risky behavior can create streaks of high returns as investors keep plowing money into hot corners of the market – but whenever that happens, bubbles tend to inflate and eventually burst.
The bottom line: Today’s skimpy bond yields and overvalued equities suggest that it would be prudent to prepare for lower long-term returns on savings.
As always, please do not hesitate to communicate with the writer if you would like additional information on this topic.
Joel Attis is a Senior Financial Advisor with AttisCorp Wealth Management and IPC Investment Corporation. Comments or questions may be submitted to Joel at email@example.com, or he may be reached at 855-1155.