Skip to content

Using the Canada Pension Plan (CPP) as a guide … what would an investor’s portfolio look like?

There is some logic behind using the CPP as a guide (doesn’t have to be the CPP, could be nearly any other pension plan … see previous post). The rationale is to simply piggyback off of all of the people, technology, expertise and other resources that the CPP utilizes … just copy their portfolio. The contrary argument might be that if you expect to benefit from CPP someday, then your own portfolio should complement rather than duplicate the CPP’s. Meaning it has to look different.

If an investor were to use the CPP as a guide and copy the CPP’s asset allocation and maybe region, currency and sector allocations, (rather than do one’s own investment planning work, in attempt to shortcut what an individualized investment portfolio should look like), then their portfolio might have some of the following characteristics (aka the components of a good Investment Policy).

Asset mix:


The most important decision first. It’s the allocation that determines investment outcome more than any other decision an individual investor can make. The individual’s asset mix would not exactly replicate the CPP’s asset allocation. But the big decisions – how much in stocks, bonds, real assets – can be easily duplicated. (Next time).

What does this mix do for the individual investor?

Simple diversification. Volatility moderation. (Stock down, bonds up). But importantly, participation in an array of markets and opportunities.

And what kind of performance can the individual investor expect?


The CPP required return was CPI + 4% (about 6.5% – 6.75%). Recently, this number is 6.2%. Note this is ‘required’ return. Not ‘desired’ return. This is the actuarial return ‘required’ to meet its obligations. Sounds reasonable and achievable.

(By the way, it’s this ‘required return’ that has driven the asset mix above … not the other way around. Recall, also, that the required return and thus the asset allocation are driven by the profile of the liabilities. In the Individual investor’s case, the liability is future monthly retirement income).

Compare the CPP’s ‘required’ return to Individual investors ‘expected’ return.  Is there a disconnect?

During TD Bank’s Chief Economist, Don Drummond’s recent farewell tour, he talked about a TD Waterhouse investor client survey wherein Individual investors are asked what their expected returns were. The answer was: ‘About 10%’. The second survey question was where they expect to invest to get that return. The answer was ‘Government bonds’. The punch line is that Government bonds haven’t been issued at 10% for at least a decade.

Individual investors who expect 10% returns can also expect to be sadly disappointed. But worse, if they are building their retirement plans on an expected return of 10%, and actual returns are more like longer-term averages, (ie lower), then they will have no choice but to reduce their future lifestyle. (Retirement savings and thus retirement income will be less. Disappointment may cause them to take too much risk to make up for shortfalls. They may run out of time to increase savings and meaningful changes to asset allocation to impact returns may be too risky).

According to the Credit Suisse 2009 yearbook, longer term returns look like this:

Canada and the US are 5th and 4th from the right. Stock returns average 5.8% plus inflation.

The last 30 years have seen abnormally high returns from both stocks and bonds because interest rates were dropping from 20% to zero. But the next 30 years is what matters. 10% is not realistic. Better to plan for lower expected stock returns.

Again, using the CPP as a reference point, with $127.6 Billion of buying power, hundreds of professional staff, all the latest technology and 24/7/365 due diligence it needs only earn 6.2%. How can the Individual investor hope to earn 10%?

Scan thru the CPP and other Institutional pension sites and expected returns are CPP  CPI + 4% or 6.2% OMERs Long-term expected inflation plus 4.25% (6.5% in 2009) OTPP  is about the same.


CPP defines risk, like any institutional investor, as not being able to meet its current and future obligations.

Individual investors should do the same. Risk is not volatility. Risk is not being able to fund retirement income needs – being old, healthy and broke.

Individual investors ought to know that all investments can be volatile. Modern Portfolio Theory (MPT) has been around for 60 years or so. Serious investors know that ‘the’ best way to moderate portfolio volatility is thru asset allocation. It’s as simple as not putting all your eggs in one basket. Diversify. Asset mix is the most important decision investors can make yet it’s likely the least understood.

The practitioners view will be to find the most appropriate asset mix that balances the investors need for income against their capacity for risk. Instead they should be trying to balance need for income against ‘tolerance’ for risk. This is where many Advisors and Individual (and Institutional) investors go wrong. Capacity means you have the ‘ability’ to withstand long market downturns. This is different than tolerance. And everyone is different.

The science and art of asset allocation seeks to find the perfect balance that helps to ensure the investor requirements are meet but lets them sleep at night. A good risk assessment questionnaire can help.

After asset mix the most important tools that any investor – both Individual and Institutional – has to manage volatility and moderate investment portfolio performance are Dollar cost averaging (think payroll deduction for your investments), Rebalancing (think forced buy low, sell high) and income Reinvestment (think compound interest).

Time horizon:

The CPP planning horizon is 75 years.

Individual investors have trouble looking beyond the most recent week of stock market activity. Often, Individuals stop at retirement. Why? Investors accumulate to retirement then start drawing on savings. So the time horizon for the investment portfolio is not retirement but rather to age 90 or so. For the 25 year old, their time horizon is likely the same as the CPP’s.

From the CPP re:

Time Horizon: Our long-term investment time horizon and no requirement to immediately help pay benefits create competitive advantages for the CPP Fund. Canada’s Chief Actuary estimates that CPP contributions will exceed annual benefits paid through to the end of 2021, providing a 11-year period before a portion of the CPP Fund’s investment income would be needed to help pay CPP benefits. This relative certainty of ongoing positive inflows allows us to invest a higher proportion of the portfolio in areas such as real estate and infrastructure that require patient capital and which offer inflation-sensitive income streams that are a good match for the CPP’s inflation-indexed liabilities. We can also invest a higher proportion of the fund in areas such as private equity and venture capital that typically require several years to generate returns. Also, substantial annual inflows allow us to make investments with new cash rather than having to sell existing investments to fund new opportunities. 

Focus on risk/return management: Our activities are focused on achieving, at a minimum, the projected return required to help sustain the CPP. Based on reasonable demographic and economic assumptions, the Chief Actuary has projected that the CPP’s current benefits and contribution rate are sustainable for at least the next 75 years, the length of the Chief Actuary’s study period. The sustainability of the CPP depends on various economic and demographic factors and assumptions. The assumptions are subject to review every three years when the Chief Actuary updates the plan’s projection for review by the federal and provincial finance ministers, who serve as stewards of the CPP. 

Dalbar has been measuring the effects of investor decisions (buying, selling and switching into and out of mutual funds) for over 25 years. Their 2006 study showed that the average holding period for mutual funds is 4.3 years – “the highest level since 1984”. Not even a full business cycle. Before compounding can even start.

John Bogle points out that between 1945 and 1965; annual mutual fund portfolio turnover was 17% (a stock was held for an average 6 years). In 2005, the average turnover was 110% (11 months). Both Individual investors and Mutual fund managers have become stock ‘traders’ rather than ‘owners’.

Institutional investors offer an alternative guideline for time horizon.


The time horizon for ‘savings’ is likely much shorter than the time horizon for ‘investments’. Savings might have a purpose in the 5 to 10 years, say. If that’s the case, monies shouldn’t be in stock market, probably not real estate and perhaps only in short term bonds if at all.


CPP has a socially responsible investment policy (called: environmental, social and governance (ESG)), wherein they MUST consider the investment merit of all investments. Most Institutions take an ‘active’ approach where they influence Corporate activity by voting according to their holdings whereas Individuals more often choose the passive approach of simply trying to exclude certain holdings.

Personal circumstances or other special considerations might also be included here.


Institutional pension plans not taxable and Individual investor registered savings are not taxable.

Non-registered, savings are taxable so Canadian individual investors should consider the significant tax benefits to dividends over other forms of investment income. In fact, in Canada, the tax advantage is such that non-dividend paying investments pale in comparison (for the ‘average’ investor).


Total costs for the CPP are about 0.43%. (Pages 50, 94, 95 – Operating, investment management and transaction).

Individual investors can pay 2.5% plus for some mutual funds, about 1% to 1.5% for some index funds and about 0.09% to 1.5% for ETFs.

I pay about 0.23% using ETFs for my RRSP assets.

More on ETFs later.

The Individual investor can adopt some of the Institutional principles of investment planning work by copying a pension plan. The investment portfolio will look somewhat like a pension plan and the starting point is better than having done no planning work at all.

In fact, by replicating the CPP, the Individual adopts many of the components of an Institutional investment policy. These factors – Returns (required and expected), Risks, Time Horizon, Liquidity, Unique preference, Tax and Cost – ought to be the major components of an Individual investors policy. By copying an Institutional pension plan, the Individual is effectively doing investment planning work of their own.

Mission accomplished.

Next time?

Implementing the CPP using ETFs.

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


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

%d bloggers like this: