Buck The Herd Instinct And Follow These 5 Steps For Better Returns

Original article by Michael Nairne, Financial Post, Jan. 30, 2015

With falling interest rates and plunging oil prices battering investors’ psyches, many of the same questions creep into investors’ minds: What kind of return are stocks going to end up delivering this year? Which market is going to do better – Canada or the United States? Are interest rates ever going to go back up and when? How do I approach bonds this year, given the market?

Important questions, there is just one thing wrong with them – the time frame. Most individual investors are building wealth for retirement or are in retirement and facing lifestyle funding challenges that will persist into old age.

Instead of fussing about immediate returns, investors should be concerned about the long-term returns on which they are building their investment strategy. Then the critical question becomes: What returns can I reasonably expect from bonds and stocks over the next 10 to 15 years?

Like all projections, long-term return projections are estimates and subject to error. What might be surprising to many investors is the fact that long-term return forecasts are actually more stable than short-term forecasts.

Short-term market returns are influenced by unpredictable events such as economic shocks, geopolitical issues, monetary policy changes, and wide swings in investor sentiment, as we’ve seen only too clearly in the first part of 2015.

In contrast, a number of studies have found that long-term stock market returns are dependent on more fundamental factors, including current valuation levels, population and economic growth as well as corporate profitability and productivity.

At the beginning of every year, our firm reviews the long-term return forecasts that are the critical inputs into our strategic asset-allocation models. We recently completed our analysis of the projections of major investment organizations. Here are five important takeaways we can share with investors.

Don’t overload on U.S. stocks.

Recent sizzling returns always exert a magnetic pull on investors. Don’t be tempted: returns south of the boder are expected to be lower going forward. J.P. Morgan Asset Management has estimated that U.S. large-cap stocks will return 6.5% annually over the next 10 to 15 years, about the same as Vanguard’s estimate. This return is down from the 7.7% annual return of the past decade and way below the 9.9% of the past 20 years.

Invest internationally.

Nearly every forecast we reviewed has higher estimated long-term returns for the developed stock markets in Europe and Asia rather than the U.S. For example, Portfolio Solutions has projected a 7.4% long-term return for international stocks. The reason – international equities are much cheaper than North American stocks.

Buy emerging markets.

With emerging markets out of favour now, compelling valuations combined with higher anticipated population and economic growth has led to the foremost return estimates. J.P. Morgan Asset Management has forecast an 8.75% long-term annual return while Portfolio Solutions’ estimate clocks in at 9.0%.

Bond investors should plan for a drastic haircut.

The investment Strategy Group at Vanguard has forecast that the long-run median return of investment-grade bonds globally will be in the 2% to 3.5% range, primarily as a consequence of today’s low bond yields. Contrast this number with the 5.3% average annual return of Canadian bonds over the past 10 years, and bond investors could face a stunning 50% drop in return from this asset class.

Look forward, not backward

Although it’s important to assess your portfolio’s historic performance, it’s even more vital that you update your long-term investment strategy, asset mix, and financial plan to incorporate changing future long-term return expectations. Pension plans do this; so should you.