FP Canada issues guidelines every year to help financial planners make long-term financial projections for their clients that are objective and unbiased. The guidelines include assumptions to use for projected inflation and investment returns, wage growth, and borrowing rates. It also includes “probability of survival” tables that show the life expectancy at various ages.

The 2021 Projection Assumption Guidelines were of particular interest because, well, a lot has happened since the 2020 guidelines were published last spring. How should we project inflation and investment returns as we get to the other side of the pandemic and economies start opening up again?

Will we see sustained higher inflation? Should we expect any returns at all from bonds or cash? Should we lower our expectations for future stock market returns?

Remember, these are long-term projections (10+ years). That’s very different than guessing the direction of the stock market for 2021, or predicting whether we’ll see a short burst of inflation in late 2021, early 2022.

The inflation assumption of 2.0% was made by combining the assumptions from the following sources (each weighted at 25%):

• the average of the inflation assumptions for 30 years (2019 to 2048) used in the most recent QPP actuarial report
• the average of the inflation assumptions for 30 years (2019 to 2048) used in the most recent CPP actuarial report
• results of the 2020 FP Canada/IQPF survey. The reduced average was used where the highest and lowest value were removed
• current Bank of Canada target inflation rate

The result of this calculation is rounded to the nearest 0.10%

Projections for equity returns were set by combining assumptions from the following sources:

• the average of the assumptions for 30 years (2019 to 2048) used in the most recent QPP actuarial report
• the average of the assumptions for 30 years (2019 to 2048) used in the most recent CPP actuarial report
• results of the 2020 FP Canada/IQPF survey. The reduced average was used where the highest and lowest value were removed
• historic returns over the 50 years ending the previous December 31st (adjusted for inflation). 

Equity return assumptions do not include fees.

Projections for short-term investments and Canadian fixed-income returns included the assumptions from QPP and CPP, the results of the 2020 FP Canada/IQPF survey, but the 50-year historical average rate was removed in 2020 as a data source. This makes sense given that interest rates were significantly higher than they are now and so it would be impossible for bonds to replicate the performance of the last 50 years.

How do you apply these investment return assumptions to your own portfolio? Let’s assume you have a balanced portfolio made up of 60% stocks and 40% bonds. Your stocks are divided up between Canadian, U.S., International, and Emerging markets. We could use Vanguard’s VBAL as a proxy:

• Canadian equities: 18% weight x 6.2% return = 1.12%
• Foreign developed market equities (includes U.S.): 37% weight x 6.6% return = 2.44%
• Emerging markets: 5% weight x 7.8% return = 0.39%
• Fixed income: 40% weight x 2.7% return = 1.08%

Total expected return from this balanced portfolio = 5.03% per year.

Subtract the MER of 0.25% and you’re left with a net expected return of 4.78% per year.

What’s interesting is how the projection assumption guidelines change over time. In 2010, the expected return for fixed income investments was 5%. In 2016 it was 4%. This year it’s 2.7%.

Projected stock returns have also been trending down, although the 2021 guidelines show modest increases for Canadian and foreign developed markets and a fairly significant increase to emerging market returns. This could simply reflect the reality that emerging markets have badly lagged the U.S. market for the past 10 years (though the same can be said for Canadian equities).

These guidelines are a helpful reminder that when it comes to our financial plan we should take a long term view of projected inflation and investment returns. The sensible approach to high stock prices is to lower your expectation of future returns, not to panic and sell while you wait for a crash that may never come. Oh, and make sure you rebalance.

This Week’s Recap:

I wrote about active versus passive investing over on the Young & Thrifty blog.

A few weeks ago I talked about revenge travel and all the pent-up demand to get away once the pandemic is behind us. I want to get ahead of the demand and book some refundable trips using my treasure trove of travel points. 

We’ve tentatively booked a week-long trip to Maui in mid-October flying with WestJet and staying at an Airbnb. 

And, yesterday I was thrilled to find 4 business class seats from Calgary to Rome in April using Aeroplan miles. We’ll attempt to re-create our cancelled trip from April 2020.

I am fully aware that there’s a large gap from where we are (especially here in Alberta) and where we need to be in order to safely travel. But a guy can dream, right? 

Weekend Reading:

Our friends at Credit Card Genius share these last chance credit card offers – get them before they’re gone!

Budget travel expert Barry Choi compares staying at an Airbnb versus a hotel. With a family of four, I’m team Airbnb all the way.

A Wealth of Common Sense blogger Ben Carlson shares why he now leases a car instead of buying. It’s a fair argument. I just don’t care about driving the latest model and prefer not to have a car payment so I can spend more on other things I care about, like travel.

Ben Carlson also declares this the most annoying bull market of all time:

“My biggest worry is the number of young people who are witnessing meme stock gains and joke cryptocurrencies going to the moon are going to develop bad habits and attitudes about the markets that will be impossible to fix.”

Most of us want to retire on our own terms but what do you do when the decision isn’t yours?

Millionaire Teacher Andrew Hallam explains why retirees shouldn’t fear stock market volatility.

Michael James on Money takes issue with having an “explore” part to your portfolio. I agree 100%.

Another useful resource here from PWL Capital’s Justin Bender with a look at how to calculate the adjusted cost base of your asset allocation ETF:

Bender’s Ottawa colleague Ben Felix published a new white paper called, “Buy the Dip“, which looked at investing a lump sum after a market decline and compared that approach to dollar cost averaging and investing the lump sum immediately. 

“While it seems appealing to “buy the dip”, the strategy implies that available capital is sitting idle while waiting for the right time to invest. This implication raises an important question about opportunity costs. Does the opportunity cost of waiting for a drop outweigh the perceived benefit of buying low?”

The results? He found that “buying the dip” is a sub-optimal strategy in both normal times and when the market appears expensive. On average, “buying the dip” trails investing a lump sum by a wide margin over 10-year periods.

My Own Advisor Mark Seed and advice-only planner Owen Winkelmolen take an in-depth look at a Millennial couple (35) who want to retire at 50.

Finally, David Rosenberg says that housing is keeping Canada’s economy going and that’s bad news when the bubble pops.

Have a great weekend, everyone!

Active investors supposedly thrive during periods of market volatility. If that’s the case, then 2020 should have been a banner year for active funds.

The year started off strong, with markets hitting all-time highs in February. Then we saw the largest and fastest market decline in history with a 34% sell-off in March. Markets then came roaring back to post positive returns, with the TSX up 5.6% on the year and the S&P 500 up 16.3%.

The promise of active investing is that a skilled fund manager can offer downside protection and outperformance through strategic asset allocation, stock picking, and market timing. How did that turn out in 2020?

The annual SPIVA Scorecard measures the performance of actively managed funds against their relevant benchmark indices. 

“Although this volatile period offered ample opportunity for stock-pickers to shine, 88% of Canadian Equity funds underperformed their benchmark in 2020, in line with the 84% that did so over the past 10 years.”

Canadian equity funds in particular had a tough year, underperforming the TSX on average by 4.8%.

Canadian equity funds can largely be described as “closet index funds“, meaning their holdings largely represent the broader index (since Canada’s market is not very diverse), but they charge high active management fees. That combination is guaranteed to underperform an index fund.

Dividend funds performed much better versus their benchmark, with just 44% trailing the Canadian Dividend Aristocrats Index. But, it was also the only category to post negative returns on the year. Dividend funds lost 1.2% in 2020, while the Index lost 2.3%. The track record for dividend funds over 10 years is awful, with 91% failing to beat the Index.

U.S. equities have offered the best returns over the past decade, including in 2020. However, 69% of U.S. equity funds failed to beat the S&P 500 last year, and an incredible 95% of active U.S. funds have underperformed over a 10-year period – falling short by an average of 4.1%.

Finally, the active fund industry loves to praise yesterday’s winners but the SPIVA report accounts for survivorship bias and tells us that 54% of all funds in the eligible universe 10 years ago have since been liquidated or merged.

The SPIVA results are not surprising if you’ve followed the active versus passive investing debate. It’s incredibly hard to beat the market, and even more difficult to do it with any consistency over time.

And it’s not just a fee story like many stock pickers want to believe. You need to compare your own investment returns against an appropriate benchmark to determine whether your judgement is adding any value over simple indexing strategy.

As I’ve said for years, the best and most reliable investing approach is a low cost, globally diversified, and risk appropriate portfolio of index funds or ETFs.

This Week’s Recap:

My wife and I were happy to receive our first vaccine doses earlier this week. Thank you science, and thank you healthcare workers!

I’m currently reading The Data Detective: Ten Easy Rules to Make Sense of Statistics, by the incredibly gifted storyteller Tim Harford. It’s worth a read.

Mr. Harford also hosts one of my favourite podcasts, Cautionary Tales – telling true stories about mistakes and what we should learn from them.

Check out last week’s edition of Weekend Reading where I opened up the money bag to answer your burning questions.

And, from the archives, here’s how to trick your lizard brain into saving more money.

Weekend Reading:

Our friends at Credit Card Genius explain how to get a full refund on flights purchased (and cancelled) through Air Canada.

Michael James on Money advocates for a simple investing approach for the majority of investors, but here he explains why his own portfolio is complicated.

Fee-only advisor Natasha Knox explains how spouses with different risk tolerances can align their investments.

Steadyhand’s Tom Bradley offers some excellent advice about not letting portfolio creep catch you unprepared:

“If you’re deviating from your plan by tilting heavily in one direction, it should be done knowing that less diversification comes with added risk. And it should be intentional, not the result of market moves and related product promotions.”

Help! I’m afraid to retire even though I can afford to. This Kiplinger article explains why actually retiring may be the hardest part about retirement.

Can you work too long and save too much? Here’s why saving too much for retirement can be a mistake.

On Morningstar, here’s how retirees should think about inflation in 2021 (and why inflation risk is somewhat overblown for retirees).

Humble Dollar blogger Jonathan Clements explains why he’s hanging tough with his stock heavy portfolio.

If everyone should invest in index funds, why does PWL Capital’s Ben Felix still have a job? In this must-watch video, Ben defines exactly what good financial advice actually means. Bookmark this and send it to your friends and family:

A Wealth of Common Sense blogger Ben Carlson answers a common reader question about how much you should have saved in your 30s.

The Blunt Bean Counter blog looks at estate planning and how to solve the sibling wealth gap.

Morgan Housel shares a few short stories.

Finally, fee-only planner Jason Heath looks at the tax implications for Canadians who retire abroad.

Enjoy the rest of your weekend, everyone!

Welcome to another edition of Weekend Reading. I continue to receive a ton of emails from readers and clients about investing, retirement, real estate, and more. I’ll answer some of those questions here in this special Money Bag column.

We’ll look at investing in a rental property, rebalancing RESPs for older children, the limitations of Wealthsimple Trade, dabbling in cryptocurrency, and how much should you invest in your own company stock.

Buying an investment property

From Dennis:

“Hi Robb. We live in a small city outside of Toronto, where house prices continue to increase significantly. We are thinking of investing in a 2 bedroom condominium in the city, using $100,000 of our own savings plus a mortgage of $400,000, but have some reservations: (1) The rental income may not be quite enough to cover mortgage payments, condo fees etc. (2) We will have the hassle of dealing with tenants and tenancy issues (3) The housing bubble may burst and prices may stagnate. I wonder if we would be better off investing in REIT’s or something similar.”

Hi Dennis, do you already own your own house in that area? If so, you already have plenty of real estate exposure.

I think you’ve highlighted three really good reasons not to buy a rental property (regardless of the current market conditions).

And by investing in a low cost and globally diversified portfolio of index funds you’ll automatically have some exposure to REITs in an appropriately weighted allocation.

My experience working with clients who do own investment properties is that they don’t spin off as much income as you’d think, they can be a pain to manage, and you’d be better off selling them at some point anyway to top-up your investments before you retire.

Rebalancing RESPs for older children

From Shonna:

“Hi Robb, I really enjoy your blog and have been motivated to start my own journey into DIY investing. I plan to follow your lead and invest in VEQT for the foreseeable future. My question is about RESPs for my daughters, who are in grade 6 and grade 4. At what point should I reduce the equity exposure in this account? I have zero confidence in the bond market right now.”

Hi Shonna, I’m in the same boat when it comes to RESPs. My family RESP (two kids, 11 and 8) is still in 100% equities using TD’s e-Series funds. My original plan around this age was to simply start introducing the TD Canadian Bond Index fund with my regular monthly contributions. I still might do this, but I’ll likely wait another year and see what happens with bond prices.

I realize this is market timing and I should simply follow a rules-based approach, but the time horizon is still pretty long at 7-10 years so I feel confident holding 100% equities for another year or two.

Here’s a great explainer from the Million Dollar Journey blog on how he manages his own kids’ RESP portfolio: 

You could also consider Justwealth’s target education date (robo-advised) RESP portfolio. They’ll automatically adjust the portfolio allocation in much the same way that the MDJ post describes, except they use a rules-based approach to take away our decision making from the process (that’s a good thing).

If you want to avoid bonds but still want to stick with an 80/20 portfolio you could use VEQT for 80% of the balance and then perhaps open another RESP on the banking / mutual fund side of your financial institution and simply buy GICs. The interest rates will be terrible but you won’t be at risk of losing principal.

Or, go with a short-term bond fund which is less sensitive to interest rate movements (Vanguard’s VSB, for example).

Limitations of Wealthsimple Trade

From Parvinder:

“My spouse and I have an RRSP, a spousal RRSP, and a personal, joint investment account at CIBC. I’d like to transfer them over but don’t think that spousal RRSP is an account available in Wealthsimple Trade right now. Is this correct? If so what’s the best choice to handle this?”

Hi Parvinder, as you’ve discovered, Wealthsimple Trade has its limitations – mostly due to the account types it offers (only personal RRSPs, TFSAs, and non-registered investment accounts). Wealthsimple Invest, the robo advisor, does offer more account types but you wouldn’t be able to select your investments.

If you prefer to self-manage your investments and want everything in one place then consider Questrade, which offers all the account types you need. Questrade also offers free ETF purchases, so if you’re in the accumulation phase of life and just buying a single asset allocation ETF then this would work out very nicely for you.

Here’s a quick explanation on how to open a Questrade account and transfer your existing investments.

Dabbling in cryptocurrency

From Danielle:

Hi Robb, I have a question about Ripple (XRP) as an investment. I’m thinking of throwing $500 into it through the bitbuy app. My friend invested in it and has made quite a bit of money. I’ve been researching the price predictions for the next 10 years and it looks solid. What do you think?

Hi Danielle, if it’s $500 you can afford to lose then there’s nothing wrong with making a speculative bet on it. But, treat it more like casino money and not as an investment.

Price predictions are usually made by those who are heavily invested in seeing the price move up or down, so take any of that research with a huge grain of salt. Cryptocurrency is a hugely speculative asset class. It doesn’t have an expected return because it doesn’t produce anything or have any value beyond trying to sell it to someone else at a higher price.

These speculative plays tend to crash and burn hard, so getting in after an enormous run-up in prices probably doesn’t leave you with much upside. Meanwhile, there’s a LOT of downside.

Finally, beware that most cryptocurrency exchanges are largely unregulated and prone to hacks and fraud. If you want to invest a small amount just to cure your FOMO then consider using Wealthsimple Crypto, which is actually a regulated exchange in Canada. You can only buy Bitcoin or Ethereum, but it’s insured and you don’t have to mess around with digital wallets.

Telus stock versus indexing

From Jeff:

“Hi Robb, I know you are a proponent of index investing, but we buy shares of Telus every paycheque, due to the employee matching program. Telus matches us 12% (and no fees for purchasing or participating in the DRIP).

I know it may risky to have a large holding in just one company, but do you think it’s better for us to continue to invest in the Telus shares, due to the fact that Telus just spun-out Telus International and is planning to do the same with Telus Health, Telus Agriculture, Telus Security?

Also, Telus is heavily investing in 5G technology and in the internet of things, making it effectively a company that owns other companies, in the future.”

Hi Jeff, are you asking if investing in a single company in Canada, a country that makes up 3% of global financial markets, is the same or better than investing in a globally diversified portfolio made up of thousands of companies?

It’s generally not wise to have any significant amount of your retirement savings invested in the company that also employs you. Ask any former Nortel or Enron employees about that.

By all means, take advantage of employer-matching programs and discounted stock purchase plans. But once your shares exceed 5% or so of your overall portfolio, it’s probably best to move them to a more diversified basket of investments.

Weekend Reading:

Our friends at Credit Card Genius share the best credit card offers, sign-up bonuses, and deals for April.

Check out my interview with My Own Advisor Mark Seed about my journey to financial independence through entrepreneurship.

Barry Choi at Money We Have explains how to invest in index funds.

Jason Zweig at the Wall Street Journal says investors shouldn’t be fooled by the stock market’s newest magic trick:

“What happened? Did hundreds of fund managers start popping genius pills? No, although marketing departments are probably gearing up to tout their brilliance. Instead, the ghastly losses of early 2020, when stocks fell by 34%, have just disappeared from trailing one-year returns.”

A Wealth of Common Sense blogger Ben Carlson looks at what happens after the stock market is up big.

Global’s Erica Alini takes a look at average incomes relative to average home prices across markets over the last 40 years.

On The Evidence Based Investor blog, Larry Swedroe explains why older investors handled last year’s volatility worst.

PWL Capital’s Justin Bender explains how to calculate your money-weighted rate of return:

Jason Heath says Canadian inheritances could hit $1 trillion over the next decade, and both bequeathers and beneficiaries need to be ready.

Here’s why retirees should avoid being frugal with their savings:

“Having a comprehensive financial plan that considers assets, cash flow, taxes and lifestyle needs and wants is recommended for people to worry less about money in retirement, and maybe spend more.”

The always insightful Morgan Housel shares the big lessons of the last year.

Finally, a great reminder to stop thinking about what you’re retiring from and start thinking about what you’re retiring to.

Enjoy the rest of your weekend, everyone!