Weekend Reading: Projected Inflation and Investment Returns Edition

Projected Inflation and Investment Returns Edition

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?

FP Canada 2021 Projection Assumption Guidelines

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!

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  1. David @ Filled With Money on May 4, 2021 at 7:10 pm

    Meme stocks and joke cryptocurrencies definitely are not long term plays nor should people risk their entire life savings into it. But there are definitely people who are risking their entire life savings into those things…

    Every day it’s getting harder to say “that’s not the norm investing strategy to employ” but in 10 years, let’s see if that statement turns out to be false or true.

  2. Greg on May 5, 2021 at 10:48 am

    Hi Robb – are the forecasted future returns listed in the tables real or nominal? Hopefully real lol.

  3. GYM on May 9, 2021 at 12:17 am

    Exciting that you have Hawaii booked in October and Rome (business class, omg) in 2022. We have not booked our Maldives trip yet but it is expiring in 2022. I am expecting to go next year, fingers crossed. Hawaii is 70% vaccinated (I think with first dose).

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