If you are investing for accumulation for your retirement or investing your already existing assets, having a good grasp and understanding of the different asset types’ realistic return and respective risk expectations is a must.
One of the most critical components of investments is equity investing. Expected returns on equities wildly oscillated according to the vagaries of the prevailing investment climate. In the 1990s the consensus on expected long term average annualized rate of return for equities was between 10% and 12%, while general North American stock markets performed very well. These expectations have been drastically slashed since the 2000 dot-com meltdown and especially after the 2008-2009 financial collapse. Today most “experts” forecast average returns on equities between 5% and 7%.
To answer this question, we need to analyze our data. First of all, we need to establish what we mean by the “long term” when you are investing. For most Canadians, the two most important reasons to invest are either to accumulate for retirement or managing your investment during retirement to draw a reasonably sustainable income. For most, accumulation for retirement starts after acquiring their first home around the age of 35. Canada’s life expectancies, at birth, for women and men are at 84.1 and 80.0 years of age respectively (source: Statistics Canada). Your investment period between the ages of 35 to 65, granted for some it could be from and/or to a younger age, is the time when you are accumulating so focusing more on the growth of your total retirement portfolio. Life expectancies at the age of 65 for Canadian men and women stand at the age of 84.5 and 87.3 years, respectively (source: Statistics Canada). Therefore we can conclude that the most meaningful long term annualized return is somewhere between 25 years and 35 years. Based on the above, I will analyze the 30 years annualized average rate of returns on the S&P TSX as a proxy for investing in Canadian equities and on the S&P500 as a proxy for investing in US equities.
I analyzed the S&P TSX and S&P500 (US$) annualized rate of returns for all possible 30 year periods between January, 1961 and July, 2019. Monthly data on these indices was downloaded from Yahoo Finance and also from Statistics Canada. Table 1 and 2 show my findings concerning these indices’ returns:
Table 1.
S&P TSX Annualized Rate of Returns Analysis
| On Index Values excluding Dividends[1]: | On Dividend Yields[2]: | |
|---|---|---|
|
Minimum: |
4.51% |
1.63% |
|
Maximum: |
9.46% |
4.18% |
|
Average: |
6.52% |
2.63% |
|
Median: |
6.21% |
2.75% |
|
Standard Deviation: |
1.11% |
0.67% |
|
Range of Annualized Return with 95% confidence[3]: |
4.30% - 8.74% |
1.29% - 3.97% |
[1] Analysis was performed on all 30 year periods starting with ending in January, 1991 to ending in July, 2019. Data used was monthly.
[2] Analysis was performed on calendar year data between 2001 and 2019.
[3] Calculation of 95% confidance ranges is based on the assumption of normal return distributions.
Table 2.
S&P 500 Annualized Rate of Returns Analysis[4]
| On Index Values excluding Dividends[5]: | On Dividend Yields[6]: | On Dividend Yields[7]: | |
|---|---|---|---|
|
Minimum: |
5.69% |
1.11% |
1.35% |
|
Maximum: |
10.50% |
6.24% |
2.63% |
|
Average: |
7.96% |
2.93% |
1.93% |
|
Median: |
8.03% |
2.93% |
1.94% |
|
Standard Deviation: |
1.07% |
1.13% |
0.29% |
|
Range of Annualized Return with 95% confidence[8]: |
5.82% - 10.10% |
0.67% - 5.19% |
1.35% - 2.51% |
[4] Returns are on investments made in US$.
[5] Analysis was performed on all 30 year periods starting with ending in January, 1991 to ending in July, 2019. Data used was monthly.
[6] Analysis was performed on monthly data between January, 1961 and July, 2019.
[7] Analysis was performed on calendar year data between 2001 and 2018.
[8] Calculation of 95% confidance ranges is based on the assumption of normal return distributions.
For the S&P500 dividend statistics, I show my findings based on the long term monthly data (over 58 years) and also on the calendar year data from 2001. The industry consensus is that the rise of internet-related giants since 1995 resulted in declining dividend yields in the US as typically they pay no or minimal dividends and this reduces the expectations on dividend yields for in general from 2001 onwards.
The following Chart 1 and Chart 2 show the 30 years rolling annualized rate of returns, excluding dividends, ending from January, 1991 to July, 2019. Chart 3 and 4 show the distribution of annualized returns, excluding dividends, over 30 year periods also for the same time interval.
Chart 1.
Chart 2.
Chart 3.
Chart 4.
Realistic Return Expectation In Equity Investing
Based on the above findings, it is fair to say that most likely (with around 95% likelihood) annualized rate of returns over the next 30 years what investor can expect by investing in the Canadian equity market is between 4.30% and 8.74% growth and around 2.63% dividend yield or between 6.0% and 11.5% combined excluding the cost of investing. If we lower our confidence level and estimate the likely (with around 65% likelihood) annualized rate of return over the next 30 years we will arrive between 5.41% and 7.63% expected growth coupled with the same 2.63% dividend yield expectation going forward.
Assuming one invests in Canadian equity mutual funds, it is fair to say that these future growth expectations need to be lowered by the average MER of equity mutual funds (2.50%) and by the effect of normal cash drag (not fully invested all the time) on funds’ performance (0.50%) arriving at a realistic combined net return expectation of between 4.0% and 8.5%. Should you invest with a portfolio manager typically charging 1.50% instead of mutual funds’ 2.50% MER, your realistic net annualized return expectation investing in Canadian stocks for the next 30 years should be between 5.0% and 9.5%.
In respect to investing in US stocks and based on the above findings, it is fair to say that most likely (with around 95% likelihood) annualized rate of returns over the next 30 years what investor can expect is between 5.82% and 10.10% growth and around 2.00% dividend yield or between 7.82% and 12.10% combined excluding the cost of investing. If we lower our confidence level and estimate the likely (with around 65% likelihood) annualized rate of return over the next 30 years we will arrive between 6.89% and 9.03% expected growth coupled with the same 2.00% dividend yield expectation going forward.
Assuming one invests in US equity mutual funds, it is fair to say that these future growth expectations need to be lowered by the average MER of equity mutual funds (2.50%) and by the effect of normal cash drag (not fully invested all the time) on funds’ performance (0.50%) arriving at a realistic combined net return expectation of between 4.8% and 9.1%. Should you invest with a portfolio manager typically charging 1.50% instead of mutual funds’ 2.50% MER, your realistic net annualized return expectation investing in US stocks for the next 30 years should be between 5.8% and 10.1%. It should be noted that investing in US stocks not only exposes you to the risk of investing in equities but also adding foreign exchange risk. This foreign exchange risk can be (even fully) hedged or unhedged. In case of fully hedging your US investments, the cost could be quite hefty, somewhere between 2% and 3% annually. This would likely wipe out any benefit of investing in US stocks vs. Canadian stocks over the long haul. On the other hand, many professional money managers believe that if you invest over the long term in US assets, you do not need to worry about the foreign exchange risk as it will average itself out. I tend to favour this opinion.
What is also important to understand that the above return expectations will only hold if you, as an investor, will not bail out at the worst possible times and only enter later, when the market moved considerably higher. By doing this, one would fully participate in the largest downsides and missing out on good portions of the upsides resulting in a significant reduction of expected returns. Just consider the best averaging mutual fund in history the Magellan fund managed by Peter Lynch between 1977 and 1990 with an average annualized rate of return of 29.2%, more than double that of the S&P 500. Despite the stellar performance of the fund, it has been widely reported that its average investor managed to lose money on the fund.
Determining what percentage of your portfolio should be invested in equities and their different types need careful analysis and planning. Fin-Plan can help you in this regard. To ask any question about this article or to book an appointment to look at your particular case, please contact Miklos at nagy@fin-plan.ca. Miklos is a fee-only financial planner, best selling author, finance-related educational course writer, statistician and former Chair of the Canadian Institute of Financial Planners with over 25 years of experience in financial planning for high net-worth and middle-class Canadians. His Fee-Only financial planning website is at www.fin-plan.ca and his Linkedin page is at https://www.linkedin.com/in/miklos-nagy-fee-only-financial-planner/.
Copyright © 2019 by: Miklos A. Nagy
The views expressed in this material are the opinions of Miklos A. Nagy through the period ended 08/31/2019 and are subject to change based on market and/or other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Investing involves risk, including the risk of loss of principal. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed.
All rights reserved. No part of this publication may be reproduced, distributed, or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission of the publisher, except in the case of brief quotations embodied in critical reviews and certain other noncommercial uses permitted by copyright law. For permission requests, write to Miklos A. Nagy at nagy@fin-plan.ca.