The days of double digit portfolio returns are long gone. A new report from TD Economics projects that diversified portfolios will produce average annual returns of between 4% and 6% over the next 10 years.
The report forecasts that cash will likely provide an average annual return of 2.0%, with bonds returning 3.0%, and equities generating 7.0%. Using those projections, 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%.
“While there will certainly be years where these portfolios achieve higher rates of return, they will likely be offset by periods of weakness. The low return on fixed income over the next few years, especially given the potential capital losses on longer-term bonds, suggests that investors may need to have exposure to equities in order to bolster portfolio returns,” it says.
Indeed, the report notes that, based on economic fundamentals a diversified bond portfolio should return close to 5.0% on an annual average basis. However, the current yield curve is close to its historical low, “which presents a material risk to the return on bonds,” it notes.
“When interest rates do eventually increase, the prices of bonds fall – and the lower the current interest rate, the bigger the capital loss is when it increases. Thus, given that rates are so low, the increased rate of income derived from higher yielding bonds is entirely offset by the capital loss on the bond itself,” it says.
While the return on equities is estimated to be roughly 7.0%, the report notes that there will likely be large swings in equity valuations over the next 10 years; that the estimate is conservative and does not include underlying shifts in valuations; and, exposure to sector-based investments or emerging market equities could elicit higher returns, albeit with higher risk.
The report doesn’t account for the impact of exchange rate fluctuations on portfolios, noting that it expects the value of the Canadian dollar to hold up over the forecast period. “Given the prospects of strong demand for commodities and the fiscal challenges facing industrialized countries other than Canada, our assumption is that the Canadian dollar will remain strong,” it says. “Although the currency will fluctuate, TD Economics expects that the impact on portfolios on average over the next decade will be limited.”
“Some investors may be discouraged by our assessment that the average return on a balanced portfolio will be in the mid-single digits. However, it is important to remain conservative in building a financial plan,” the report concludes. “After all, the impact of getting the planning assumptions wrong is not equal in its consequences. Building a conservative plan and having a better-than-anticipated performance is a financial windfall in retirement; but, assuming higher returns and saving inadequately could lead to a lower standard of living in one’s golden years.”