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Dan's Reports
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High expectations
Advisors have work cut out for them

RBC Asset Management released the results of an investor survey this past week. After a year of strong stock market returns, RBC and Ipsos-Reid found that more than half of Canadians expect positive returns from their RRSP portfolios this year. While, on average, polled Canadians anticipate an average return of 6.3 percent, there are signs of high expectations.

Uncertainty and risk aversion

While the overall return expectation seems realistic, there are two important signs that demonstrate significant uncertainty and a continued tilt toward conservatism. The first slide in this link shows that roughly two of every five people did not know what to expect - a 77 percent increase from a year ago. Hence, the 6.3 percent average return excludes this uncertain contingent. Hence, a more complete picture of the breakdown can be summarized as follows:

- 39 percent don't know;
- 54 percent expect a gain; and
- 7 percent expect a loss.

Further, the second slide shows that nearly two-thirds of those polled generally displayed a strong aversion to risk (with almost half of those having a zero risk appetite). The trend is down from a year ago, but this remains a significant figure. Individual investors, as a group, are often out of touch with the reality of capital markets.

Future expectations

Forming expectations for stock returns need not be rocket science. Advisors can use this very simple framework. Add the following together: dividend yield, real earnings growth, inflation, and any increase in the price-earnings multiple. (Any decrease in the multiple is subtracted.)

Using current market data adds up to returns of about 6 percent in North America - or a little over 3 percent above inflation. These figures are before incorporating any expansion or contraction of the market's valuation multiple (i.e. change in P/E ratio). The conservative assumption is to assume no change, which means fairly modest returns from stocks for some time to come. With long-term bonds yielding more than 5 percent in Canada (and just under 5 percent in the U.S.), that means very little risk premium for the stock market - if any at all.

Tying this into the RBC survey means that investors will need to assume more than a little bit of risk to achieve their expected return. But most survey respondents clearly indicated that they have little or no appetite for risk. This is a significant mismatch that should not be ignored.

The opportunity for advisors

Financial advisors have an important, twofold role to play in light of this recent survey.

First, it's clear that most don't even know what they expect from their retirement savings. In my experience, many also have no idea what return they need to meet their goals. Advisors can help this uncertain forty percent by helping them form more concrete expectations via retirement projections. A thorough retirement plan will give investors a concrete estimate that can act as a target to guide the investment process.

Second, is the ongoing job of expectations. I'm not very marketing-savvy but someone who is once told me that the key to success is to "underpromise and overdeliver". In other words, setting conservative expectations improves chances of a pleasant surprise. So, if you think that my 'quick and dirty' return projections above are just a result of my cynicism, then use the figures as a baseline. Don't base any retirement plans on returns above the above figures. That way, if I'm wrong and the bulls are right, you'll look like a hero.

This is good advice whether you sit in the driver's seat of your own portfolio (and financial plan) or if others rely on your counsel.

Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at dha@danhallett.com
 
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Disclaimers: Consult with a qualified investment adviser before trading. Past performance is a poor indicator of future performance. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, financial advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. More...