Dangers of expecting too much from the market

What sort of return are you expecting in 2018 and beyond? In the summer, the Financial Planning Standards Council (FPSC) and Institut Quebecois de Planification Financiere (IQPF) released an update on their projection assumption guidelines. 

While these numbers do not tend to jump around a lot, they present a great opportunity to discuss the discrepancies between what the main Canadian planning organizations are recommending, what you might thinking and what some expert practitioners are actually recommending.  The differences are stark.

Most people I talk to who do retirement planning projections use numbers that are markedly higher than what is being recommended.  Given that it is nearly impossible to reliably determine which numbers most people are using, I’ll begin with a disclaimer that what follows are reasonable guesses based on various conversations with the people who actually do projections for their clients.

According to the FPSC/ IQPF Guidelines, reasonable return assumptions (all numbers before advisory fees and product costs) might be 4.50% for a conservative portfolio; 5.17% for a balanced portfolio and 6.00% for an aggressive portfolio.  To put this in perspective, a ‘conservative’ portfolio is 75% income and 25% equity.  A ‘balanced’ portfolio is 50% income and 50% equity – and an ‘aggressive’ portfolio is 25% income and 75% equity.

I have spoken with practitioners who use numbers like 5% for a conservative portfolio, 6% for a balanced portfolio and 7% for an aggressive portfolio.  I believe there are others who use even higher numbers.  Most advisors are using relatively high numbers, calling them “reasonable” – and then depicting people such as myself as using inappropriately low numbers.  In contrast, I suspect that in the fullness of time, it will become clearer that the lower projections are both more accurate – and therefore more “reasonable” – than what the majority of people are using.

The planning experts also make it clear in their guidelines that it is appropriate to reduce return expectations by all associated fees.  Fees, in turn, can vary greatly and are the sum of both the product costs and payments for advice.  Actual results will vary. My understanding is that most advisors DO NOT reduce their return assumptions to account for overall costs.  The head of the FPSC’s projection guidelines project has admitted as much.

Let’s assume that the average total cost (both products and associated advice) is 2%.  Taken together, the difference between the guidelines with assumed costs subtracted and what many advisors recommend (costs not subtracted) is truly astonishing:

       Portfolio Risk           Recommended      Advisor (example)

• Low Risk                     2.5%                   5.0%
• Medium Risk               3.17%                 6.0%
• High Risk                     4.0%                   7.0%

The total difference in my example is somewhere between 2.5% and 3.0%.  Remember, too, that inflation is running at nearly 2% in Canada, so that real returns (i.e. the returns after inflation) are considerably lower than what is being depicted here, as well.

Many advisors who are otherwise excellent with planning simply do not account for the impact that cost can have on their clients’ terminal wealth.  At a minimum, my sense is that they certainly don’t seem prepared to acknowledge it as a tangible and material factor in their clients’ retirement projections.

Investors need to ask their advisors about the assumptions being used in modelling their retirement projections.  If they do not, I strongly suspect that many will ultimately find that their nest egg in retirement will be much, much smaller than they thought it would be.  There’s a bank running an ad campaign that says “you’re richer than you think”.  I tend to disagree, both now and in the future.  My guess is that for the very large majority of people who are having projections run on their behalf, they will end up being much less wealthy than they thought they’d be.

John De Goey is a portfolio manager with Industrial Alliance Securities Inc. and the author of The Professional Financial Advisor IV. Industrial Alliance Securities Inc.  is a member of the Canadian Investor Protection Fund. The opinions expressed herein are those of Mr. De Goey alone and may not be aligned with the opinions and values of Industrial Alliance Securities Inc.  or any of its affiliated companies.

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