Following up on an earlier report forecasting long-term financial returns for Canadian investors, TD Economics has issued a new report focusing on long-run U.S. financial returns, which also sees portfolios returning between 4.5% and 6.5% on average annually, depending on asset mix.
According to the report, TD foresees U.S. cash providing an average annual return of 2.25%. It says bonds will likely suffer capital losses, as interest rates rise from their current lows, but that Treasuries should return 2.5%, corporate bonds should deliver 5.5%, and municipal bonds are to generate 4.5%. Overall, a balanced fixed-income portfolio is expected to return 3.75%, on an average annual basis. Equity markets will likely return, on average, about 7.0%, it suggests.
The earlier report from TD predicts similar overall portfolio returns for Canadian investors. It projects an income portfolio, with a heavy weighting in cash and fixed income will return just over 4%; a balanced portfolio should return 5.0%, and a growth portfolio, with a heavy weighting towards equities, would return 6.2%. For the U.S., it foresees a 4.6% average annual return for income portfolios, 5.3% for balanced portfolios, and 6.3% for growth portfolios.
TD says that it expects the U.S. Federal Reserve Board to keep rates at exceptionally low levels, as promised, through mid-2015. “Our base case forecast takes the FOMC at their word, with only minor upticks in the three-month T-bill rate by mid-2015,” it says. “However, the subsequent quarters should see the committee begin to rebalance monetary policy as improved economic momentum is sustained. We expect the pace of rebalancing to fall in the 100-200 basis point per annum range, returning the fed funds rate near its neutral policy stance – estimated at around 3.5% – by the end of 2017.”
Monetary policy could be affected by the pace of housing and credit market recoveries, the policy on future deficit- and debt-reduction, the resolution of the European sovereign-debt crisis, and succession at the Fed. “We believe that, on balance, the risks are tilted slightly to the upside, potentially implying an earlier start to the tightening cycle, and therefore slightly higher returns over the analysis horizon,” it says.
For bonds, rising rates will lead to lower prices and capital losses. “One way active investors can shield their bond portfolio is through underweighting long-term bonds in favor of shorter-term maturities as interest rates begin to rise, and subsequently rebalance for higher yield as rates stabilize,” it says. And, bond portfolio returns can be enhanced through the inclusion of corporate and municipal bonds, it notes.
In terms of equities, TD says that additional returns could be achieved by investing in emerging market equities, with yields expected to approach low double-digits, but these returns carry greater potential risks too.
As for the overall portfolio returns, TD allows that its projections may disappoint some investors, but stresses that a higher yield may be possible by actively managing the portfolio. “In particular, underweighting long-term bonds as rates begin to rise, taking advantage of roll-down, or moving into international equities as geopolitical risks subside, may be some of the strategies to consider,” it says. “However, active management may require substituting additional expected return for a higher degree of risk, which can be unwelcome when planning for retirement.”
Indeed, it notes that while exceeding a prudent financial plan “will result in a welcome windfall come retirement”, it cautions that the “consequences of underperforming an overly ambitious one could have dire implications for one’s standard of living.”