Just how possible are double digit returns for your portfolio?

Several years ago, when I was setting up a group RRSP for a dot com, I asked the employees what they expected from their portfolio returns on an annual basis. Given their youth, these individuals expressed that 50 percent was a reasonable return and that anything less than this was not worth considering!

Given today's market climate, these individuals would have a different perspective on market performance. The question is, how possible is it to get a double digit return on your investments given the negative equity sentiments that exist.

Here is a breakdown of asset classes and the expectations for future returns:

Money Market
This sector should reflect a low and stable inflation environment, which limits nominal interest rates, and could result in low single-digit returns for money market products this decade. If the economy grows at its potential rate over the long run, one may assume the Bank of Canada will adopt a neutral stance on monetary policy. That would mean a Bank of Canada nominal overnight rate of 4.5%. Since the benchmark for money market rates is three-month T-bills, which have historically delivered a return of approximately one-quarter of a percentage point below the overnight rate, that implies a yield for money market products of about 4.25%.

Bonds
With the federal governments in Canada and the United States having put their fiscal houses in order, there will be a limited supply of federal government bonds in the years ahead. This will increase market demand for long-term corporate and provincial debt, reducing the default risk premium that investors require on such instruments and narrowing the spread between yields on corporate and provincial bonds versus their federal counterparts. A well-balanced portfolio of Canadian bonds could deliver a real return over the long run of about one and three-quarter percentage points above the three-month T-bill rate, implying an annual real return on Canadian bonds of about 6%, including inflation.

Equities
It is expected that corporate profits will mirror the growth in GDP at 4.5%. They point out that investors require a premium for the increased volatility in valuations of equities, so they set the floor at the potential rate of return for bonds of 6%. While the past two decades have seen declining inflation and low interest rates, making equity investments attractive, we are now seeing lower risk premiums demanded on equities following the market corrections of the past two years, as well as fewer companies offering dividends. In fact, the dividend yield on shares in the TSE 300 dropped to 1.54% in December 2001, from 3.71% in 1990. They do expect this trend to continue, albeit at a much slower pace. These factors should contribute to an average annual total return over not greater than 8% over this decade. Since the U.S. Federal Reserve has a slightly higher tolerance for inflation, U.S. equities could see average annual returns of around 9%, with global markets still commanding a higher risk premium which could mean returns at around 10% annually for international equities.

How does this work out?

Conservative investors whose portfolios consist of around 20% in money market, 30% in domestic bonds, 30% in international bonds and 20% in domestic equities could see a return on their overall portfolio of around 6% annually. More aggressive investors, whose portfolios contain 20% domestic bonds, 50% domestic equities, 15% U.S. equities and 15% in other international equities could see a return slightly above 8%.

No one really knows what is going to happen in the future. Yet we all still have to plan for tomorrow today, so it's worth considering what rates of return may be realistic in the years ahead. And it's always better to be conservative when planning ahead.

Realizing lower returns than during the 1990s doesn't mean you can't achieve your financial goals, it just means you'll need to plan more carefully.

To discuss the contents of this artlcle, please feel free to contact John Klotz., B.A.,CFP.,CLU.,CH.F.C., RHU. John can be reached at (416)-595-7484 ext. 305 or email at johnk@lms.ca