Accepting Market Returns
A few readers have expressed concern about their recent investment performance. In most cases, these investors are holding a sensible, low cost, globally diversified portfolio of index funds ranging from conservative (40% stocks, 60% bonds) to balanced (60% stocks, 40% bonds). One reader said:
“Psychologically, it’s tough to put money in when returns have been so low.”
When you invest in a passive portfolio that tracks broad market indexes you can expect to earn market returns minus a small fee. This is far and away the best and most reliable way to invest for the long term.
But sometimes market returns can be disappointing in the short term. Investors might be experiencing that right now. In fact, if you’ve recently moved away from actively managed funds or stock picking to embrace a portfolio of passive index funds, you might be wondering if that was a wise decision.
Market returns have been dismal this year compared to returns from the previous two years. But context matters. FP Canada’s projection and assumption guidelines suggest future expected returns of approximately 4.78% per year for a global balanced portfolio.
Meanwhile, an actual global balanced portfolio represented by Vanguard’s VBAL and iShares’ XBAL returned about 15% in 2019 and 10.5% in 2020. Even a global conservative (40/60) portfolio returned about 12% in 2019 and 10% in 2020. This is highly unusual.
| ETF Name | Ticker | YTD | 2020 | 2019 |
|---|---|---|---|---|
| Vanguard Conservative ETF | VCNS | -0.82% | 9.41% | 12.10% |
| iShares Core Conservative ETF | XCNS | -0.86% | 10.33% | n/a |
| Vanguard Balanced ETF | VBAL | 1.12% | 10.24% | 14.91% |
| iShares Core Balanced ETF | XBAL | 1.41% | 10.58% | 15.19% |
| Vanguard Growth ETF | VGRO | 3.11% | 10.89% | 17.84% |
| iShares Core Growth ETF | XGRO | 3.01% | 11.42% | 17.96% |
| Vanguard Equity ETF | VEQT | 5.56% | 11.29% | n/a |
| iShares Core Equity ETF | XEQT | 4.76% | 11.71% | n/a |
A reasonable investor adjusts his or her expectations of future returns. After all, a conservative or balanced portfolio certainly won’t continue to deliver double-digit annual returns forever.
Indeed, reasonable investors should accept market returns and not fuss over short-term fluctuations or periods of underperformance.
But if your framing around index funds is about performance chasing rather than diversifying and keeping costs low then it’s going to be hard to wrap your head around accepting market returns – especially when returns have been poor.
This has been my fear all along about persuading so many investors to switch to indexing. Will they calmly stay in their seats when markets inevitably fall? Or will they panic and move on to a different strategy?
Related: Top ETFs and Model Portfolios for Canadians
Let me state this as clearly as I can.
Market fluctuations are normal. Markets fall from time to time. Often by a lot. That’s a feature of your index funds, not a bug.
If you hold an asset allocation ETF, or invest through a robo advisor, your portfolio will automatically rebalance, selling what has gone up and buying more of what’s gone down.
Investors in the accumulation stage should embrace falling prices, since they can pick up more shares with every new contribution.
To quote Warren Buffett:
“If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall.”
Final Thoughts
The strong past performance of conservative and balanced portfolios have clouded our view of what reasonable market returns look like. We’re used to double-digit gains, so now we’re upset that the return on a 50/50 balanced portfolio is flat year-to-date (it’s only May, by the way).
Ignore the urge to do something with your portfolio – like it’s an appliance that needs repair. Stick to your plan.
Impatient investors might try to juice their returns by dialing up the risk and adding more stocks. That’s a mistake. Stocks add more volatility to your portfolio, so if you’re unhappy with flat returns in the short-term, you’re going to really hate it when stocks fall by 20% or more, taking your portfolio down for the ride. See March 2020 for proof of volatility in action.
So, if you’re invested in a low cost, globally diversified, and risk appropriate portfolio, congratulations on a perfectly sensible approach. You’re not doing anything wrong. Be patient, keep adding new money regularly, and try your best to ignore daily market movements.
Your article came just in time before I was about to make some goofy changes to my portfolio. I’ll stick to my initial passive plan of all in one ETF, thank you!
Hi Katia, thanks for sharing. I’m glad it helped you reconsider making an irrational change.
Robb, I love this post. Question: if you where 75 years old and had 500K and needed approximately $2500. per month where would you put your savings? Life expectancy say 90.
Hi Gary, thanks for the kind words. Unfortunately I can’t give you a specific answer to your question without knowing much more information, including how that $500k is allocated between registered accounts (RRIF, LIF, TFSA) and taxable accounts. The RRIF and LIF will have ever increasing minimum withdrawal rates (ex. 5.82% at 75, 6.82% at 80, 8.51% at 85) so that will certainly play a role in your retirement income withdrawals.
Hi Gary. Fyi… I’m 64 years of age, and in my Canadian dollar “cash” trading account at a discount brokerage I own 22,800 units of “ZWC”. ZWC is the symbol for BMO Canadian High Dividend Covered Call ETF. The ETF pays a monthly dividend of 11 cents per unit. In my owning 22,800 units of ZWC, the monthly dividend amount I receive in my account is $2,508. The dividend distributions from this Canadian ETF are considered eligible dividends for the ‘dividend tax credit’.
ZWC may not be for everyone, but it satisfies what I’m looking for. The most recent valuation for ZWC is $18.09 per unit. You may want to research and consider this ETF for your monthly income needs.
Thanks Richard. I will take a look.
Great post Robb. I think on the equity side, patience is key, especially with the FP Canada future expectations.
Although I struggle on the fixed income side. My cave man brain is having trouble understanding the concept of holding something like VAB or XBB going forward. When the duration is about 7.90 and the YTM is 1.68 (VAB). More downside risk (govt interest rate/inflation) than potential upside gain.?
For example, we came off a 40 year bond era where most were rewarded, but if the future looks opposite, and there’s no shortage of ‘inflation articles’ out there right now in the financial pornography world, what is the fixed income side to do for the new era.
One strategy I suppose is to hold on and embrace lower bond prices and average down if rates do increase, it will take time for these bond ETFs to consume it, assuming the other indexers don’t run and panic (as mentioned in your article).
Would it be unreasonable to replace this allocation with a short-term bond, like VSB, to shore up the duration risk? Or even go into a HISA, I know the yield isn’t there, especially after inflation and possibly taxes. But if it helps cave men like me sleep at night?
Thoughts?
Thank you for your work here, great site, lots of valuable info. I’ve been following for many years.
Max
Hi Max, thanks for your comment. It can certainly make sense to unbundle something like VBAL and replace it with 60% VEQT, 30% VSB, and 10% high-interest savings (not a recommendation, just an example). High interest savings sounds counter-intuitive if inflation is higher than expected, but the typical central bank response to inflation is to increase rates, which should also drive up the interest rates on deposits.
There’s no perfect hedge against inflation so the best approach is diversification in a risk-appropriate manner – that diversification should include holding assets with a positive expected return, even if those return expectations are much lower in the future.
The most recent Rational Reminder podcast had a great discussion on inflation hedging: https://rationalreminder.ca/podcast/150
Thanks for the reminder Robb. I have purposely avoided looking at my fairly new Wealthsimple accounts. Having lost big time in March 2020 in an other portfolio and being in the decumulating phase its hard to do. Barb
Hi Robb,
Since the performance of the VBAL hasn’t been too far off VGRO or VEQT, would it be a good idea to switch to the balanced fund while the market seems high to offset risk of a downturn? Or with a 25+ year investment timeframe would you recommend to stay the course (I’m in a 90/10 with 50% each in VEQT/VGRO)?
Hi Mike, I don’t think that approach makes sense. Your investing strategy shouldn’t change based on market conditions. Once you decide to hedge your bets then you’re effectively market timing, which no one can do with any reliability.
When do you decide to move back to 90/10? After a crash, or after a crash and then a recovery? Future outcomes are unknown, so any number of possibilities could occur between now and whenever you decide the market is no longer too high. Heck, maybe it keeps climbing and then you’ll feel the regret of missing out on those gains.
Markets hit all-time highs more often than you realize. And with a 25-year time horizon and a 90/10 portfolio you should accept that your dispersion of returns is going to be somewhere in the range of -30% to +30% in a given year.
Finally, I’ll just say that if the prospect of your portfolio dropping by 30% in a year is frightening to you then perhaps you would be better served in a less aggressive portfolio. A 60/40 product like VBAL should have a tighter dispersion of returns, maybe in the range of -20% to +20% in a given year.
But that would be a long-term portfolio decision and not a market timing decision.