Posts Tagged ‘Inflation’
Wednesday, February 29th, 2012
Among the most important things that good advisors bring is the ability to help clients make the right trade-off between risk and return … and also to help clients understand the critical impact of the time frame over which they hold investments on the volatility they experience.
One of the most important conversations these days is about the amount of risk that clients should take in their portfolios.
This month’s column in Investment Executive outlines three steps to make that conversation an effective one.
Step One: Talk about long-term returns
You could start by reminding clients of after-inflation returns for different investments for the 84 years from 1926 (as far back as we have really good data) to the end of 2009.
This compares large cap US stocks to intermediate, 5 year Government bonds and T bills. Note that you should frame this in terms of real, after– inflation returns — what really matters to clients investing for retirement.
Note that after inflation, stocks have returned three times bonds and ten times T bills.
Then translate that return into the real return on client portfolios.
For someone investing $100,000 in stocks, the after-inflation appreciation of $259,000 is almost five times that in bonds and almost twenty times the gain in T Bills, which just barely beat inflation.
Step Two: The odds of losing money
Next, talk to clients about the historical experience of losing money in stocks after inflation, based on different holding periods.
Historically, holding stocks meant that after inflation you lost money about one in three years.
Looking at three year periods reduces the chances of losing stocks to about one in four.
In ten year timeframes, investors lost money 12% of the time — based on the experience since 1926; you have to go out to twenty years to completely eliminate the chances of losing money in stocks.
Step Three: Communicate this visually
Finally, portray the nature of the experience in a way that investors can relate to.
Tags: Client Portfolios, Conversations, Critical Impact, Government Bonds, Holding Periods, Important Things, Inflation, Investing For Retirement, Investment Executive, Investments, Risk And Return, Stocks Bonds, T Bills, Three Steps, Three Times, Time Frame, Timeframes, Twenty Times, Twenty Years, Volatility
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Wednesday, November 24th, 2010
Of all the assumptions that go into retirement plans, none has a bigger impact than the expected return on a client’s portfolio.
Media coverage about the returns investors can expect is not generally helpful in bringing clarity to this question . Often the media features attention-seeking apocalyptic voices of doom. And in part it’s because when the media talks about a return forecast, they often fail to clarify whether that return is before or after inflation and whether it’s for equities only or for a balanced portfolio.
Framing a client conversation
Given the importance of the decision on the expected return on investments, this is one of the most important conversations you can have with your clients.
You could start by reminding clients that over the very long term, stocks have averaged a pre-inflation return of about 10% a year – even after the market turmoil of 2008. Then acknowledge that in the last while, many credible industry voices have suggested that it would be over-optimistic to expect this kind of return going forward
When it comes to your return assumptions, there are obvious costs to being too bullish — overly rosy assumptions can result in complacency and ultimately disappointment as people to fail to save enough and fall short of their goals as a result.
But there’s a price to being too conservative as well, as overly pessimistic assumptions can lead to undue stress and to investors making bad financial choices. After all, if you think you’re only going to get low single digit returns on stocks, why not just buy GICs?
Three key decisions
To think intelligently about expected returns, you need to talk to your clients about three things.
First, shift their thinking to after inflation or real returns instead of the nominal, pre-inflation returns so commonly used. This way, you’ll focus on spending power – what really counts in retirement. Indeed this is what sophisticated pension plans and high net worth investors focus on.
Second, you have to help clients extend their timeframe. The shorter their timeframe, the more dispersion they’ll experience on returns – pick one year as your time horizon and you could experience swings of 50% in either direction.
Even five and ten year periods subject you to substantial swings in returns on stocks, especially if your clients do what many investors do – and set their expectations based on what happened in the last three to five years.
The only way to bring stability to investors’ expected returns is to follow pension funds and high net worth investors – and look out fifteen or twenty years. That may seem an unduly long timeframe to some clients, but in fact that’s the minimum horizon that most Canadians need to think about. Even if your clients are a 65 year old couple, half the time one of them will live to age 90. And one in ten couples will see the last survivor reach age 98 – a thirty-three time horizon.
Looking inside average returns
The third key decision for investors is to look beyond averages.
Recently, I sat down with Michael Nairne and his team at Tacita Capital to look at data on stock market returns in the U. S. going back to 1926.
In the 85 years since then, after inflation returns have averaged 6.6%. The big difficulty with an average number is how often you’ll be below it. Given the hardships imposed from underperforming a return assumption, when selecting the forecast return for the equity component of their portfolio you need to help clients look beyond the average return to the distribution of returns that got to that average –that will tell them how badly they might fall short based on historical precedent.
Since 1926, there have been 65 twenty-year periods. If we list the real returns during those 65 periods from highest to lowest – and look at how often those returns happened, here’s what you end up with.
Annual return after inflation in 65 20-year periods - 1926 to 2009:
|Return||% of time this return
or higher happened
|# of times this return
or higher happened
|13.3%||1%||1 out of 65 20-year periods|
|12.7%||5%||3 out of 65 20-year periods|
|11.9%||10%||7 out of 65 20-year periods|
|10.8%||20%||13 out of 65 20-year periods|
|9.3%||33%||22 out of 65 20-year periods|
|8.5%||50%||33 out of 65 20-year periods|
|5.0%||67%||42 out of 65 20-year periods|
|3.3%||80%||52 out of 65 20-year periods|
|2.2%||90%||59 out of 65 20-year periods|
|1.8%||95%||62 out of 65 20-year periods|
|0.8%||100%||65 out of 65 20-year periods|
Picking the right number
In recommending the expected return for the stock component of clients’ investments, you could pick the after inflation return that’s half way down the list – that would give you a return of 8.5%. Despite this, given the price of falling short of the return assumption, few advisors would suggest assuming the historical median of an 8.5% real return on stocks.
For most investors, assuming a real return on equities of 3% to 5% will likely make sense; 5% was achieved two thirds of the time, 3% was exceeded 80% of the time.
To put these numbers in perspective, the CPP Investment Board assumes a real return of 4.2% for a portfolio with a 60% stock weighting, reflecting equity returns of 5% or more. And a recent article in the Financial Analyst’s Journal forecast a real return of 4% for U.S. stocks.
Finally, for clients who want to be really cautious, you could pick 2%; 1.8% was delivered 95% of the time, in 62 out of 65 twenty year periods.
Of note, the worst after inflation returns all occurred during the high inflation years in the 1970s. As a result, your recommendation on the return assumption for the stock component of clients’ savings will be heavily influenced by your concern about a return to inflation.
Picking the return assumption to recommend for equities will vary with your own and your clients’ attitude towards risk – there clearly is no one right number.
However, by focusing on after inflation returns, taking a long term view and digging deep into the range of historical experience, you can help clients end up with a realistic number that strikes the right balance between undue optimism and extreme pessimism.
To read the full column in Investment Executive, click here:
Tags: Balanced Portfolio, Clarity, Compendium, Complacency, Conversations, Disappointment, Doom, Financial Choices, Industry Voices, Inflation, Market Turmoil, Media Coverage, Media Features, Pessimistic Assumptions, Retirement Plans, Return Assumptions, Return On Investments, Target, Term Stocks, Undue Stress
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Tuesday, October 19th, 2010
Not many topics are more emotionally charged than house prices. Part of the reason is the amount of myth, anecdotal conversation and pure misinformation on this topic.
In many cases, that creates a big opportunity for advisors to add value by introducing facts and objective information.
That’s been the subject of my last two Globe columns — last week’s looked back at the historical returns on home ownership, today’s examines what current house valuations look like by historical standards.
Links to both columns can be found at the bottom of today’s email, should you want to email them to clients.
Houses as an investment — the verdict of history
The last ten years have seen annual increases of 8% in house prices — the best decade on record.
Some Canadians expect those kinds of gains to continue — and are almost sure to be disappointed.
So last week’s Globe column tackled the question: What are the facts on historical returns on houses?
Depending on your source, the answer is that after inflation, returns on houses have been either slim or nonexistent.
Phil Soper of Royal Lepage said that since the early 1960s, Canadian house prices have seen an average annual gain after inflation of 2.4% — this compares to a long term real return on stocks of over 6%.
Another perspective came from Cynthia Holmes, who teaches real estate at the Schulich School of Management at York. She suggested that over the longer term, on average house prices only increase with inflation and there are no real returns at all — this is supported by a study of houses in central Amsterdam going back 350 years.
Confirming her view, in this weekend’s National Post Robert Shiller of Yale was quoted that from 1880 to 1990, US housing prices yielded a zero rate of return.
Today’s email contains an interview with Cynthia on this — you can also watch it here:
Housing prices today — fairly valued or a bubble?
Today’s Globe column shifts from the past to the present, examining the substance behind recent suggestions that housing prices are at bubble levels.
In March, the New York Times devoted a rare article on Canada to this topic.
And a couple of weeks back, David Rosenberg of Gluskin Sheff released a report suggesting house prices could fall by 20%.
Here’s the Rosenberg report: https://ems.gluskinsheff.net/Articles/Coffee_with_Dave_042310.pdf
Here’s how it was covered in the Toronto Star: http://www.yourhome.ca/homes/realestate/article/799961–canadian-housing-market-correction-in-the-cards-says-economist
And here’s the New York Times story: http://www.nytimes.com/2010/03/20/business/global/20real.html
Housing prices through the lens of affordability
Phil Soper of Royal Lepage points out that over time housing prices and incomes move together — although there are lots of periods along the way where incomes get ahead of prices or prices get ahead of incomes.
Since 1985, RBC economics has tracked affordability of houses in 100 neighbourhoods across Canada, looking at the percentage of the median household’s income it would take to carry a 1200 square foot bungalow, assuming a 25% down payment and including utilities and property taxes. The higher a percentage of a household’s income it takes, the less affordable houses are.
Today’s Globe column contains a chart of historical and current affordability in Calgary, Montreal, Toronto and Vancouver — this chart is found at the bottom of this article.
Since 1985, the average proportion of income to carry a bungalow across Canada has been 39% — Montreal ‘s been 37%, Calgary 40%, Toronto 49% and Vancouver 57%.
There have been big variations along the way of course — as house prices ran up in the 1980s, affordability declined to the point that by 1990 it took an average of 53% of income to carry a bungalow, with Toronto hitting 73%. The high prices and the poor affordability that resulted led to the lost decade for house values in the 1990s, when prices actually declined in real terms.
At the end of December, affordability in most markets was close to historical levels, although RBC points out this was partly a function of mortgage rates well below what would normally be expected. When they did the calculation assuming normal mortgage rates, affordability dropped below the long term average — the good news was that affordability was still well above the all time highs.
The only market where alarm bells went off was Vancouver — assuming normal mortgage rates, at the end of December it would have taken 81% of a median household’s income to carry a bungalow, just below the all time high set in early 2008.
Based on this analysis, today’s column draws two conclusions.
First, with the exception of Vancouver, houses do appear expensive but are not at bubble levels.
And second, there’s no rush to buy — while house prices could continue to increase, if they do it’s likely they’ll correct back down.
Here’s a link to the RBC report on affordability, which contains historical data on twenty cities across Canada: http://www.rbc.com/economics/market/pdf/house.pdf
And here’s the summary of long term affordability that’s in today’s Globe:
% of typical household’s income required to carry an average bungalow
|Long term||at 12÷31÷09||12÷31÷09 adjusted||All time high
for normal mortgage rate
|National||39%||41%||45%||53% (Q2 1990)|
|Vancouver||57%||69%||78%||81% (Q1 2008)|
|Toronto||49%||49%||55%||73% (Q2 1990)|
|Montreal||37%||39%||44%||53% (Q2 1990)|
|Calgary||40%||37%||42%||58% (Q2 1990)|
Tags: 1960s, Canadians, Central Amsterdam, Email, Globe, Historical Returns, Home Ownership, House Prices, House Valuations, Inflation, Last Ten Years, Misinformation, Myth, Phil Soper, Rate Of Return, Robert Shiller, Royal Lepage, School Of Management, Schulich School, Zero Rate
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Wednesday, February 3rd, 2010
Even with the recovery in the last nine months of 2009, many clients are still anxious about owning stocks.
If you’re running into nervous clients, you might want to refer to a recent interview with Jeremy Siegel, the Wharton academic who’s the leading authority on long term asset class returns.
A link to the full interview is below. Among the key points Siegel makes:
- Stocks today are fairly valued based on current earnings – and over the next year will likely offer better returns than bonds and cash
- Why stocks are likely to be significantly higher by 2012
- Inflation is not going to be a concern in the near to mid term
- The reason US deficit spending isn’t the biggest cause for concern going forward
- Why the last ten years have been so miserable for stocks – and the reason that investors can expect after inflation returns of 6 to 7% on stocks going forward
Here’s the full article: http://knowledge.wharton.upenn.edu/article.cfm?articleid=2411
And for clients who’d like to watch Jeremy Siegel talk about his views, below are five short video interviews he did last September that you can email to clients.
Stocks for the long run and long term returns http://www.clientinsights.ca/video/stocks-for-the-long-run-and-long-term-returns/type:investor
The growth trap and the role of dividends http://www.clientinsights.ca/video/the-growth-trap-and-the-role-of-dividends/type:investor
Looking back on the past ten years in markets – what went wrong http://www.clientinsights.ca/video/looking-back-on-the-past-ten-years-in-markets-what-went-wrong/type:investor
Today’s valuation levels and market outlook http://www.clientinsights.ca/video/today-s-valuation-levels-and-market-outlook/type:investor
The case for international investing http://www.clientinsights.ca/video/the-case-for-international-investing/type:investor
Tags: Asset Class, Bonds, Deficit Spending, Dividends, Earnings, Expert Evidence, Fears, Inflation, Jeremy Siegel, Last September, Last Ten Years, Leading Authority, Market Outlook, Nine Months, Stocks, Term Asset, Upenn, Valuation Levels, Video Interviews, Wharton
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