We live in extraordinary times. Over the past decade we have experienced two major stock market crashes and two recessions, with the spectre of another one looming. Interest rates are at historic lows. Property values in the United States have plummeted and now there are signs that Canada may be heading in the same direction. Many investors have understandably lost confidence and the psychological scars may affect an entire generation.
The e-mails that I receive reflect this malaise. People are unhappy with the poor performance of their investment portfolios over the past several years but, with interest rates so low, they don't know where to turn.
"For eight years the stock market has not done well," wrote one Quebec man. "I'm thinking of quitting the market and investing some place else. Do you think GICs or bonds are a better idea? I know they will not pay you big interest but I will not lose any money. So far I lost $25,000 in three months."
He's not alone. A very discouraged woman wrote: "About 10 years ago I had about $110,000 in my RRSP. I became a single mom and my finances changed considerably. I have not contributed any more than a few thousand dollars max per year since then. I had expected that the interest from my funds would reinvest itself and although I wasn't contributing I would see an increase over a ten-year period. (I understand the long-term ups and downs.) Today, 10 years later, my RRSP is worth $87,000. I have all the statements for the last 15 years and it seems that any growth I have gained was equal to what I contributed myself (a shoe box under the bed would have had the same result, maybe better). It seems that once you stop contribution to RRSPs they stop growing."
Those examples reflect the frustration many people are feeling these days. Nothing seems to work. Investing in the stock market is a recipe for losing capital. Putting money in GICs is safe but the returns are abysmal. What to do?
"I just received $12,000 that was an employer settlement," an Ontario man wrote. "The money is now sitting in an account making almost nothing. I am 64 and do not want to lose it in high-risk investments. I would appreciate any suggestions on what to do with that money."
So just how bad are things, really? There's no doubt that, unless you're a nimble trader, it has been difficult to make big profits so far in the 21st century. But everyone should have been able to earn at least a modest return on their money over the past five or 10 years. It didn't require sophisticated market timing or stock picking. Simple portfolio discipline would have been enough.
I spent a few hours recently constructing some basic model portfolios and looking at their returns over the past five and 10 years. The periods covered ended on July 31, 2010 and in each case I used the average annual compound rate of return of the relevant mutual fund category to calculate the results. These were performance figures anyone could have achieved. There was no rocket science involved.
I set up four portfolios for each period: Conservative, Balanced, Aggressive, and Balanced International. The first three were invested exclusively in Canada while the fourth added global bonds and equities to the equation.
Every portfolio made a profit over both five and 10 years. In some cases, the gains were small but not one lost money. In other words, by simply investing in average mutual funds and maintaining portfolio discipline, anyone could have come out ahead.
Interestingly, the lower-risk portfolios produced the best returns. The Conservative portfolio was allocated as follows: 15% Canadian money market, 60% Canadian fixed income, and 25% Canadian equities. Over the 10 years to July 31, the average Canadian money market fund gained 2.17% per year, the average Canadian bond fund was ahead 6.88% annually, while the average Canadian equity fund added 3.52% each year. The average annual compound rate of return for this portfolio over 10 years was 6.03%. At that rate, an investment of $10,000 made on Aug. 1, 2000 would have been worth $17,063.73 on July 31, 2010, despite the two stock market dives in between. That is very respectable growth at low risk.
Over the past five years, the average annual returns for each category were 1.96% Canadian money market, 5.47% Canadian fixed income, and 1.24% Canadian equities. Overall, the Conservative portfolio gained an average of 3.96% each year. A $10,000 investment made on Aug. 1, 2005 was worth $12,142.39 on July 31 of this year.
For the Balanced portfolio, I changed the asset allocations to 10% Canadian money market, 40% Canadian fixed income, and 50% Canadian equities. Over 10 years, this portfolio gained an average of 4.87% per year while the five-year annual return was 3.08%. After 10 years, the portfolio was worth $16,086.89.
The Aggressive portfolio consisted of 5% Canadian money market, 20% Canadian fixed income, and 75% Canadian equities. It fared worst among the purely domestic portfolios, not surprisingly in view of the market crashes, but it still managed small profits of 4.21% annually over 10 years and 2.18% over five years. In this case, a $10,000 investment made a decade ago would have grown to $15,110.08.
Finally, I looked at how foreign diversification would have affected the results. The Balanced International portfolio was allocated as follows: 10% Canadian money market, 20% Canadian fixed income, 20% global fixed income, 25% Canadian equity, and 25% global equity. The latter category dragged down the returns, with negative performance over both five and 10 years. Despite this, the overall portfolio managed an average annual gain of 2.64% over the decade and 2.18% for the past five years. After 10 years, the value was $12,970.79.
These numbers show that even in times of great turbulence such as we are experiencing, it not only possible but relatively easy to make modest profits and avoid big losses. But you must have a plan that you are comfortable with and stick to it. If you change direction every year or two, you'll probably end up in the same position as our money-losing readers.
The e-mails that I receive reflect this malaise. People are unhappy with the poor performance of their investment portfolios over the past several years but, with interest rates so low, they don't know where to turn.
"For eight years the stock market has not done well," wrote one Quebec man. "I'm thinking of quitting the market and investing some place else. Do you think GICs or bonds are a better idea? I know they will not pay you big interest but I will not lose any money. So far I lost $25,000 in three months."
He's not alone. A very discouraged woman wrote: "About 10 years ago I had about $110,000 in my RRSP. I became a single mom and my finances changed considerably. I have not contributed any more than a few thousand dollars max per year since then. I had expected that the interest from my funds would reinvest itself and although I wasn't contributing I would see an increase over a ten-year period. (I understand the long-term ups and downs.) Today, 10 years later, my RRSP is worth $87,000. I have all the statements for the last 15 years and it seems that any growth I have gained was equal to what I contributed myself (a shoe box under the bed would have had the same result, maybe better). It seems that once you stop contribution to RRSPs they stop growing."
Those examples reflect the frustration many people are feeling these days. Nothing seems to work. Investing in the stock market is a recipe for losing capital. Putting money in GICs is safe but the returns are abysmal. What to do?
"I just received $12,000 that was an employer settlement," an Ontario man wrote. "The money is now sitting in an account making almost nothing. I am 64 and do not want to lose it in high-risk investments. I would appreciate any suggestions on what to do with that money."
So just how bad are things, really? There's no doubt that, unless you're a nimble trader, it has been difficult to make big profits so far in the 21st century. But everyone should have been able to earn at least a modest return on their money over the past five or 10 years. It didn't require sophisticated market timing or stock picking. Simple portfolio discipline would have been enough.
I spent a few hours recently constructing some basic model portfolios and looking at their returns over the past five and 10 years. The periods covered ended on July 31, 2010 and in each case I used the average annual compound rate of return of the relevant mutual fund category to calculate the results. These were performance figures anyone could have achieved. There was no rocket science involved.
I set up four portfolios for each period: Conservative, Balanced, Aggressive, and Balanced International. The first three were invested exclusively in Canada while the fourth added global bonds and equities to the equation.
Every portfolio made a profit over both five and 10 years. In some cases, the gains were small but not one lost money. In other words, by simply investing in average mutual funds and maintaining portfolio discipline, anyone could have come out ahead.
Interestingly, the lower-risk portfolios produced the best returns. The Conservative portfolio was allocated as follows: 15% Canadian money market, 60% Canadian fixed income, and 25% Canadian equities. Over the 10 years to July 31, the average Canadian money market fund gained 2.17% per year, the average Canadian bond fund was ahead 6.88% annually, while the average Canadian equity fund added 3.52% each year. The average annual compound rate of return for this portfolio over 10 years was 6.03%. At that rate, an investment of $10,000 made on Aug. 1, 2000 would have been worth $17,063.73 on July 31, 2010, despite the two stock market dives in between. That is very respectable growth at low risk.
Over the past five years, the average annual returns for each category were 1.96% Canadian money market, 5.47% Canadian fixed income, and 1.24% Canadian equities. Overall, the Conservative portfolio gained an average of 3.96% each year. A $10,000 investment made on Aug. 1, 2005 was worth $12,142.39 on July 31 of this year.
For the Balanced portfolio, I changed the asset allocations to 10% Canadian money market, 40% Canadian fixed income, and 50% Canadian equities. Over 10 years, this portfolio gained an average of 4.87% per year while the five-year annual return was 3.08%. After 10 years, the portfolio was worth $16,086.89.
The Aggressive portfolio consisted of 5% Canadian money market, 20% Canadian fixed income, and 75% Canadian equities. It fared worst among the purely domestic portfolios, not surprisingly in view of the market crashes, but it still managed small profits of 4.21% annually over 10 years and 2.18% over five years. In this case, a $10,000 investment made a decade ago would have grown to $15,110.08.
Finally, I looked at how foreign diversification would have affected the results. The Balanced International portfolio was allocated as follows: 10% Canadian money market, 20% Canadian fixed income, 20% global fixed income, 25% Canadian equity, and 25% global equity. The latter category dragged down the returns, with negative performance over both five and 10 years. Despite this, the overall portfolio managed an average annual gain of 2.64% over the decade and 2.18% for the past five years. After 10 years, the value was $12,970.79.
These numbers show that even in times of great turbulence such as we are experiencing, it not only possible but relatively easy to make modest profits and avoid big losses. But you must have a plan that you are comfortable with and stick to it. If you change direction every year or two, you'll probably end up in the same position as our money-losing readers.
