Investors should ignore short-term volatility and focus on long-term returns because portfolio returns will average between 6% and 8% over the next 10 years, according to a new report from TD Economics.

“To say that the last couple of years have been a challenging time for investors would be a gross understatement. In 2001 and 2002, equity markets were pummelled by the combination of widespread economic weakness, U.S. corporate accounting scandals and uncertainty over a possible war in Iraq,” says Craig Alexander, senior economist and author of the report.

He notes that while money market returns fell historically low levels, government bonds delivered handsome returns, thanks to a “combination of the weakness in equities, reduced inflation expectations and safe-haven buying in fixed-income markets fuelled capital gains on top of the regular coupon payments.”

“Although diversification across asset classes has limited the overall losses incurred on most portfolios, there is little doubt that investors are still shell-shocked, as illustrated by the vast amount of funds sitting in cash at the moment,” Alexander observes. “As hard as it may be, investors need to look past the day-to-day volatility in markets and focus on their long-term financial plans and objectives.”

In his report, Alexander aims to estimate expected long-run returns for various asset classes. He predicts cash to return 4.60% on average over 10 years. For fixed income investments, Alexander says the Scotia Capital Markets Universe Bond Index will deliver an average annual return of approximately 5.75% over a 10 years, significantly below the more than 8% annual gains recorded in the last three years. Expect Canadian equities to deliver 7.75% over 10 yeas, wihile U.S. stocks should yield 8.75%, he says.

For non-U.S. international equities, using the MSCI EAFE index as a benchmark, Alexander says analysis of the long-term economic prospects for the countries in EAFE suggests that the index will rise at annual rate of 8% over the next decade.

“Applying the assumed returns on the various major asset classes to the five model RRSP and non-RRSP portfolios of TD Waterhouse Financial Planning suggests that an average annual yield of 6.3% to 8.3% is a realistic estimate,” says Alexander.

“This is a dramatic improvement over the performance of most portfolios in recent years, but falls well short of the double-digit gains that some investors came to expect in the late 1990s,” he concludes.