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All I want is 10%.

We hear this almost daily.

Is the expectation for 10% investment returns realistic?

Consider this.

Long-term annual stock returns in Canada average about 5.9% plus inflation. About 8.4% with inflation.

Returns over the last four years have been well above average. Over 20%. The last six years have been closer to average. About 10%.

2007so far 2006 2005 2004 2003 2002 2001
TSX returns 3.44% 17.26% 24.13% 14.48% 26.72% -12.44% -8.39%

source: (to 23 Feb 2007).

That’s history.

What about ‘expected’ returns?

Here is a simple analysis (borrowed from Dimson, Marsh, Staunton, Financial Analysts Journal, January 2004). Assume a standard 60% stock, 40% bond allocation. Canada bonds currently yield about 4.2%. To get 10% portfolio returns, stocks must return 13.9% – well above the long-term average. Is 13.9% realistic?

To average 8.4%, returns must sometimes be above and sometimes below average.

The Canada Pension Plan is about a $100B fund. It has some of the best investment minds available. The CPP ‘expects’ returns to average 4.2% plus inflation annually. About 6.7%.

Ontario Teachers Pension Plan manages about $96 Billion. Teachers’ long-term goal is inflation plus 5%. About 7.5%.


There’s more. The economic backdrop includes an inverted yield curve, uncertain inflation, moderating global growth, lower commodity prices and unknown impact from a weakening US housing market … well, you get the picture.

Most important, corporate earnings have peaked. If investors’ value stocks based on future earnings stream, then expect stock prices to moderate.

So is 10% realistic? Maybe. Given a long enough time horizon and significant allocation to non-North American markets. But not as likely in the short-term. Not without assuming significant risk.

As markets continue to hit new highs, and risks escalate, discipline to process is needed most – when the temptation to sway from proven methodology is greatest. Remember, it’s about protection of capital with ‘prudent’ growth. See, we can’t control returns. We can, however, manage risk.

And right now that’s the best defense.

Review your Investment Policy. What did you answer when your Advisor asked – What is your required (versus expected) rate of return? What is your tolerance for volatility? What’s your time frame?

Your portfolio should reflect your policy starting with asset allocation. Asset allocation determines expected performance AND volatility. As always, the golden rule is risk management through balance, broad and global diversification and a healthy mix of non-correlated asset classes to offset traditional stocks and bonds. This is what works in a down market.

Then, with cash on hand, we wait. We wait for opportunity to present itself.

To quote Michael LeGault, “Subjectivity and emotion have displaced empirical evidence, [logical] reasoning and skepticism.” We would rather continue with a defensive posture for our clients, prepare their portfolios for opportunity and find ourselves in a position of having to explain muted performance than participate in a market correction. Based on the evidence, that’s one risk we’re willing to take.

Diversify your portfolio. Hope for 10%. But don’t expect it.

Originally published in the Business Thompson Okanagan news, March 2007.

Doug Cronk CFA is Manager, Investments for a Canadian Pension Fund.

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