Q: I noticed that over the long term (10 to 20 years) the average returns of your model portfolios are quite similar regardless of the asset allocation, but the maximum losses vary dramatically. Would you say that people saving for retirement may as well be less aggressive, since their goal can still be reached with less risk? – L.V.
One of the first principles of investing is that more risk should lead to higher returns, while playing it safe comes at the cost of slower growth. That’s why I was surprised when we compiled the historical returns of my model ETF portfolios. Over the 10- and 20-year periods ending in 2014, you were barely rewarded for taking more risk:
As you can see, a portfolio of 30% equities and 70% bonds enjoyed an annualized return of 7.48% over 20 years, while portfolios with 60% and 90% equities returned only slightly more. Yet equity-heavy portfolios would have endured a much rockier ride: the investor with 30% stocks never suffered a loss of even 8%, while the poor sap with 90% equities lost almost a third of his portfolio during the worst 12 months (which was February 2008 through March 2009).
When you look at those numbers, it’s hard to see why anyone would take risk in the stock market when the price is so high and the payoff so low. If you’re a long-term investor, why not pick the most conservative portfolio and reap the rewards without the sleepless nights?
Bully for bonds
Before answering that question, it’s important to understand why the model portfolios performed so similarly over the last 20 years, and then to consider whether the next 20 years are likely to unfold the same way.
Let’s take a step back and consider the bigger picture. According to the Credit Suisse Global Investment Returns Yearbook 2015, the world stock market has delivered an inflation-adjusted average annual return of 5.2% since 1900, compared with 1.9% for bonds. It seems reasonable to conclude that patient investors will usually be rewarded for the risk they take when investing in equities. But that doesn’t mean those rewards will show up over every period or in every country, and the last 20 years in Canada were decidedly unusual.
The model portfolio performance numbers begin in 1995. In January of that year, 10-year Government of Canada bonds were yielding 9.34%, well above their historical average. During the next 20 years, yields trended consistently downward, and by the end of 2014 that 10-year Government of Canada bond was paying 1.79%.
When yields fall, bond prices rise, so these plummeting yields led to a huge bull market in bonds. During the 20 years ending in 2014, the broad Canadian bond market delivered returns of about 7.2% annually. After inflation, those returns were still well over 5%, compared with our 1.9% long-term global average. What’s more, only two calendar years saw negative returns (1999 and 2013), and the biggest loss was a measly –1.2%.
During the same two decades, Canadian and US stocks (in Canadian dollar terms) both delivered about 8.8% before inflation, but international and emerging markets stocks came in at just 4.6%. And in order to get those mediocre returns you would have had to endure the dot-com bust (three consecutive years of negative returns from 2000–02) and the worst market crash (2008–09) since the Great Depression.
All told, then, the 20 years ending in 2014 were a magnificent time to be a bond investor in Canada, and a pretty difficult one for anyone with a global equity portfolio. If you have a time machine, it certainly would make sense to transport yourself back to 1995 and put your entire portfolio in 20-year bonds.
The past is not prologue
But does it make sense to expect similar results going forward? It’s hard to imagine how anyone could make that argument. While no one can forecast equity markets with any accuracy, bonds have a narrower range of possible outcomes. Interest rates have fallen even further in 2015, and if you buy a 10-year Government of Canada bond today and hold it to maturity your annual return will be just over 1.3%. And although rising rates would lead to higher expected returns in the future, it’s difficult to see how the broad bond market could possibly deliver returns like those of the previous 20 years.
So while it is tempting to expect annual returns of 7% from a portfolio of 30% equities and 70% bonds, it’s probably fantasy. That doesn’t mean you should take more risk in your portfolio than you can comfortably handle. It just means your financial plan should use much more conservative assumptions. And it probably means you should plan on saving more.
“So while it is tempting to expect annual returns of 7% from a portfolio of 30% equities and 70% bonds, it’s probably fantasy. That doesn’t mean you should take more risk in your portfolio than you can comfortably handle. It just means your financial plan should use much more conservative assumptions. And it probably means you should plan on saving more.”
I disagre with what stated above, yes it should exclatly mean you should take more risk.
I am always wonder why somebody can’t sleep at night because of money in an stock market index that he will not use for 20 years and more. All I can think is these persons have poor financial literacy or they don’t have a lot of money and plan to use it soon, so the plan to saving more may not been available to them.
Also I always see advice to control our emotion but a conservative porfolio base on sleep time is rule by emotion. Sometime I wonder if the risk tolerance is a concept that allow adviser to do a losy job on their client on financial literacy so if market go south the client won’t complain or fired him because they didnt lose as much money.
I never thought I’d see a post here that basically says “This Time, It’s Different” :P The most famous words in investing…
Just teasing, thanks for the background!
What about negative interest rates? Can’t inflation rear up and convince the banks it pays to pay people to borrow money?
Any chance we could get the stats for the 3 portfolios if we invested the same amount every year? It would be interesting to see if the 3 portfolios still have similar relative returns
Question … What do you perceive as being the next best thing next to bonds to invest in if one does not want to buy bonds. i.e. would a REIT be a good swap in.
Just curious. Just did a comparison with yahoo/finance of TD Bank versus XIU and SP500
From 2000 to 2015 TD 800% XIU Just under 600% and SP500 just under 200%
Am I reading this right ? If so why bother with all the noise ?
@Ian: This is a common question. The most useful way to measure portfolio returns is using a time-weighted method, which specically removes the influence of contributions and withdrawals. So whether you contribute once a year, every month, or not at all, you would always get the same return. This is how all investment funds report their returns. A money-weighted return (i.e. one that takes into account when contributions and withdrawals are made) would have to be specific to each individual investor and would service no purpose for a model portfolio.
@Ammar: There really is no bond alternative that has a similar risk/return profile, except perhaps GICs. REITs are equities, and they are not suitable as a bond alternative.
@Mike: Are you suggesting that people simply buy one stock that did well in the past rather than building a diversified portfolio?
Very timely article, Dan. I was investigating this very topic last night and found couple of web sites that have data going back to early 1950s. I wanted to see what happens to bond returns in rising yield environments.
http://research.stlouisfed.org/fred2/graph/?id=IRLTLT01USM156N,IRLTLT01CAM156N,
As you see, the 10 year CDN bond year rose from 3% in 1955 to 17% in 1980 and since 1980’s CDN 10 year bond yield has been coming down and is now at 1.38%
Then I wanted to see how were the bond returns in rising bond yield(and vice versa)
from 1961 to 1980, all Canadian bonds avg return was 4.8% with std deviation of 5.5 and from 1980 to 2014, avg return for all CDN bonds was about 9% with std deviation of 7.5.
You can use the following site to see returns of different asset allocations/asset classes over various time periods. I found it to be very useful.
http://www.ndir.com/cgi-bin/downside_adv.cgi
Onkar
Not suggesting only one stock but there seems to be a lot of opinions on what to invest,bonds,mutual funs,ETFs,s when a very simple portfolio of quality companies will do the trick
I have of portfolio of 20 securities including some ETFs, such as TD, TRP, KEY,ATD ,PJC
Some ETFs,s such as VXC ZLB,ZDM
@ccp yep totally. The reason why I asked is that from what I understand that stock and bond returns are very consistent over any 40 year period. OTOH For periods less than 40 years there is a lot of variation from historical averages.
Anyways since making regular investments (rather than a lump sum) decreases variability I was just curious if it would bring the returns of the 3 portfolios closer to their respective long term averages
I’m a bit new to all of this, so forgive me for sounding stupid or like I’m out in left field, but does purchasing physical silver have any value in a diversified portfolio? How do metal prices relate to bonds? I know I can hold a metal-based ETF, and I know I can have a dealer store it for me within a TFSA, sortof, but my goodness a block of metal in hand is hard to argue with. Thoughts? Just wondering if the previous comment about alternatives to bonds can be addressed this way.
@Mike
Have you read the about or FAQ pages? This is a site that espouses passive indexing with fixed or pre-planned asset allocation and balancing – that you’re as well off trying to get out of your own way. If you pick wrong in your ‘quality companies’ – and many have gone downhill in the past – and you’ve generally done more damage relative to the passive index than any gains by your good choices.
While I agree that REITs are closer to stocks than bonds, they have a considerable relationship with real assets, and could be considered a different asset class vs equities – they do have different performance characteristics vs stocks, and can certainly help serve as a diversifier. As you say, I wouldn’t replace bonds with REITs…. the correlation data tells you that’s a poor trade-off. However, I like to stretch my portfolio with as many differently performing assets as I can, and try to take advantage of the rebalancing effect. International vs Domestic stocks (EM are still unique) value v growth, large v small, technology & the core sectors, convertibles, and high div stocks – all behave a bit differently. On the bond side you have corporates, treasuries, TIPS, GNMA, EM Bonds, Hi Yield (not an exhaustive list by any means, and some classes, like commodities, appear to be no help at all for a B&H portfolio, it seems to be the tactical allocation folks who find commodities useful.) If your 401k has this kind of variety of selections and auto-rebalances it’s easy to do even if the theoretical boost is modest. Certainly time is better spent figuring out how to earn more or save more, but for those who get a kick out of exploring asset allocation, there is data out there to suggest that there may be opportunity to improve performance a little.
Hi CCP,
I was hoping you could do an article on securing a line of credit(or similar) with a balanced portfolio in order to add more positions to the same balanced portfolio. With rates so low and potentially getting even lower next week, I feel a lot of investors might be doing/wondering/considering the same. Interest only payments would be tax deductible if I’m not mistaken. If we had the option of 30 yr terms at 3.85% like the US, it would be far less risky but with 5 year max term here…???
There’s a lot of wiggle room in between a LOC at 2.85% and the average return of 7%. That being said, if rates pop whilst portfolios are in a bear market, you’d be up the creek.
I found this article but it’s a bit over my head at the moment;
https://www.blackrock.com/institutions/en-us/literature/whitepaper/leverage-in-risk-parity.pdf
Does anyone have any material or links to recommend?
Thanks,
Doug
@Doug: This could be the topic of a lengthy discussion, but in general my feeling is that leveraging is only appropriate for the very small percentage of investors. It looks very compelling on paper, e.g. your comments that “there’s a lot of wiggle room between an LOC at 2.85% and the average return of 7%.” The problem is that to get that 7% average return over the last 20 years you would have had to live through the dot-com fiasco and the 2008-09 financial crisis. How many people would have been able to sleep at night with a portfolio that was devastated by those bear markets and a huge loan that magnified those losses?
If an investor in a high tax bracket wants to use an LOC to make a small RRSP top-up loan they can pay off in a year or two, that’s probably fine (even though it’s not tax deductible). But take out a big LOC on your home equity to invested in a taxable account? Not something I would recommend for anyone but the most experienced, battle-hardened investor.
@Doug
Just think about the 6 foot tall man who drowned while walking across the river that had an average depth of 5 feet.
Averages don’t mean much when you bring deviation into the picture.
You have to be able to handle the most extreme depth possible, in order to cross that river safely.
Not trusting a bit this shaky market, and though I’m in my early forties, I chose to invest in the 70 % fixed income (VAB) / 30 % equities ( VCN + VCX ) Couch Potato Portfolio.
But if the biggest problem of the financial system is the catastrophic amont of bad debt going around, how safe am I when the largest part of my savings are in a bond market likely to fall like a set of dominoes ?
How did VAB reacted in the 2008-2009 crisis ? Is it the “least bad” solution ? If Hell breaks loose, and I can’t see how we can avoid it sooner or later, will my boat only be the slowest to reach the bottom ?
@onkar
Thank you for the great links. I too have been looking for data to compare the performance of different duration bonds over a slightly longer timeframes while interest rates/ yields are rising. Most information I have read on the topic focuses on the very short term returns and states that short term bonds perform better during rising interest rates.
Since short term bonds were only available after 1980 I chose to compare performance of Long Canadian Bonds and All Canadian bonds (shorter) from the period of 1971 to 1980 over which period the Canadian 10 year bond yield increased from ~6.6 to ~12.9. Over that period average annualized returns were as follows:
– Long Bonds earned 6.44%, STDV of 8.37%
– All Canadian bonds earned 5.3%, STDV 4.75%.
From 1981 to 2014 Canadian 10 year bond yield bond yields dropped from ~12.8 to ~2.3. Over that period average annualized returns were as follows:
– Long Bonds earned 11.48%, STDEV of 10.71%
– All Canadian Bonds earned 9.61%, STDEV 7.55%
– Short Canadian bonds earned 8.22%, STDEV of 5.82%
At face value it appears that the longer term bonds have significantly higher STDEV (risk) and therefore lower risk adjusted returns. However, the longer the bond maturity the higher degree of inverse relationship with equities. In other words some of the additional volatility experienced by the longer term bonds actually helps the level out a balanced portfolio.
To display this I looked at the same two time periods but with this time with a portfolio of 25% bonds, 25% TSX, 25% MSCI, 25% S&P500.
1971 to 1980:
– Portfolio with Long Bonds earned 13.04%, STDEV of 14.96%
– Portfolio with All Canadian Bonds earned 12.75%, STDEV 13.90%
1981 to 2014:
– Portfolio with Long Bonds earned 11.17%, STDEV of 12.37%
– Portfolio with All Canadian Bonds earned 10.7%, STDEV 11.98%
– Portfolio with Short Canadian bonds earned 10.35%, STDEV of 11.68%
My conclusion here is that in over 10+ year time horizons history has shown that long bonds (both on their own and as a part of a diversified portfolio) have had earned higher annualized returns regardless of which way interest rates/ bond yields were going. These higher returns came with higher volatility. I do not think it is as clear cut as a lot of people are making out to be that short maturity bonds are better during rising interest rates.
@CCP & Jim
Battle hardened…? Yes. Experienced…? Not at all. I tend to forget that performance won’t always be the way it has been since I first started investing three years ago.
I will heed your warnings.
Thank you very much for your comments.
@CCP:
What about the after tax returns of those different portfolios? The returns may have been very close in registered accounts, but not so much in taxable accounts… would you suggest a higher equity allocation if your portfolio is held mainly inside taxable accounts (ex business owner investing inside his corporation instead of RRSP/TFSA)?
@Doug: One thing to keep in mind is that there is no fundamental difference between leveraging and simply increasing your equity allocation beyond 100%. ie, the difference between 80% equities and 100% equities is roughly the same as the difference between 100% and leveraging your portfolio to 120%.
It’s not exactly equal, because you generally will pay higher interest on your margin than you will earn on fixed income, so there’s a bit of an added hit in going over 100%. (And so it makes no sense to hold fixed income if you’re leveraged.) So if you don’t have the risk tolerance to go to 100%, going beyond certainly doesn’t make sense.
Another thing to consider: In theory, over the long term, stocks should pay more than bonds because of their risk premium. That expected risk premium is relatively stable. (Unlike the ex-post premium, which of course can vary widely.) Say the equity risk premium is 5%. That means, if safe bonds are returning 5%, the expected return of equities is 5+5=10%. (Again, not guaranteed of course; think of ‘expectation’ like a best guess.) This point is, if safe bonds are instead returning 2%, the expectation of equities is now 2+5=7%.
So yes, low interest rates do make leverage more attractive on a relative basis. But in absolute terms, your expected increase in performance by adding more equities (either by increasing your allocation toward 100%, or using leverage to go beyond 100) is the same regardless of interest rate, being based solely on the risk premium.
@Jas: I would never recommend changing one’s asset allocation based on tax considerations. If your only goal was to maximize after-tax returns, then everyone should be 100% equities. The asset allocation decision is primarily about risk management.
@Doug: I’ve been investing for 5-6 years now, so we’re a bit in the same boat.
My cousin works for a Big Bank (Investing branch) and while he doesn’t want to give me specific investment advice, he still wanted to check that I wasn’t making mistakes. He just asked me one question.
« Are you borrowing to invest? »
« No »
« Good. Don’t do that. »
@Paul: I hope your cousin’s employer doesn’t know about that advice. He’d get fired. :)
Seriously ?
@Paul G: I’m half-serious. Bank employees who encourage people not to borrow money probably aren’t made Employee of the Week.
@Paul:
From my personal experience I would confirm that bank employees seems much more inclined to suggest to leveraging strategies (borrowing to invest) than independent advisors…
@Nathan
Thank you for explaining that in a way that I fully understand. I’m reading all of you loud and clear.
@Paul G
Hope you have a job to offer your cousin ;)
Past performance is not an indicator of future results, as the saying goes.
@CCP, PaulG: I imagine that he went to work at that bank after being fired by a Winnipeg-based company.
Dan,
So, are you against borrowing to invest at any interest rate? Even at bank’s Prime rate (around 2.85%) for RRSP contribution? Maybe this can be a good topic for the next post?
@Behzad: Every situation is different. An RRSP loan at a low interest rate may be just fine for someone in a high tax bracket. (I would recommend borrowing the money just before the contribution deadline and then immediately using the tax refund to pay down part of the loan.) But the investor would still need to have the discipline to pay down the loan quickly and to endure a fair bit of stress if the markets tanked shortly after the investments were made.
With interest rates at extreme lows, is there any merit to the notion that couch potato investors should start contributing more new money to equities vs bonds? I’m not a bond expert by any means, but it seems to me that if interest rates have (almost) nowhere to go but up, bond prices must have nowhere to go but down?
I realize any interest rate rise will likely happen very, very slowly… but still wondering whether my logic makes any sense.
I find it funny how just 4 years ago my 60/40 equity/bond index portfolio was called “very aggressive” by advisors and other investors who highly recommended that I move into something even more stable (e.g., gold, real estate.) This exact same portfolio allocation advisors/investors now tell me is “ultra conservative” and I should consider 100% equities. I don’t listen. Most people don’t know what they’re talking about and form opinions from a recency position.
I’m a couch potato now–not “aggressive” or “conservative” or anything else. Every time I consider changing from 60/40 to 70/30 I slap myself and realize others are getting to me. Stick to the plan, DCA a chunk of each paycheck, rebalance in June and/or December if things get off, and forget it.
A *very* interesting stat to show would be how many of those people with 100% equities bailed on their portfolio in 2009 versus those with a balanced allocation. The huge win with indexing doesn’t seem to be what you pick more than sticking with what you pick.
@James
Interest rates going up means more interest. Not sure why so many are concerned with rising rates, to me it means more interest even though the value of the actual bonds will drop a bit. To me it sort of like when a company increases their dividend and the stock takes a short drop but in long run will be better. Rising interest rates are a good thing.
The people that complain about low interest rates are also the same people that will complain about the rising rates !!!
@James: Will a portfolio more heavily weighted to equities have a higher expected return? Of course, and that’s always been true. But it will also carry more risk, and the real issue is whether investors can stick to their strategy if and when their portfolios plummet in value. Most cannot do this with discipline. If expected returns on balanced portfolios are lower now, a more prudent strategy is to save more, not to take on more risk. More here:
https://canadiancouchpotato.com/2013/01/21/does-a-6040-portfolio-still-make-sense/
@Jake: Good points, which I have written about here:
https://canadiancouchpotato.com/2013/09/16/ask-the-spud-should-i-fear-rising-interest-rates/
I do apologize in advance if this seems a bit off topic.
I am new to index investing and after researching through multiple forums, especially this one, I recently opened up a TD Waterhouse TFSA account and am housing the 4 suggested TD e-series index fund in an assertive model portfolio.
I understand that index investing is a long term passive investment strategy but lately I have been reading about a potential impending stock market crash and that successful long term investors like Warren Buffet are cashing out a big chunk of their stocks.
I am wondering if Its advisable to wait it out for a potential crash/correction before index investing or stick the course regardless of the current/imminent market conditions.
Thanks
@AJ
I’m sure Buffet has been wrong before !
The “experts” have been saying for a few years now that interest rates would go up and if you would have listened to that you would have missed out on some nice returns if you would have waited and are still waiting for interest rates to go up to buy bond funds.
If this money is for the long term why worry about a crash? But if you are planning to need this money in 5 years you shouldn’t be putting it in equities in the first place. You have to sit down and make descions about when you will need the money. Those descions will be more important than timing thte market as to when you will need the money.
Saving more is easier than trying to get an extra 1 or 2 % that equities give in a balanced portfolio.trying to time the market.
@AJ, I see a lot of ads talking about “Warren Buffet’s prediction about the end of the world” but I doubt any of them are true.
Guessing when the market will go down is basically impossible. If you invest now you will start making money. Eventually the market will go down but it’s quite possible that you earn more before then than you would lose in a correction so you still come out ahead unless it happens shortly after you invest. And of course once it does happen, if you wait it out the market will recover in time. Since the market is rising most of the time, you will most likely lose money by waiting. Would you turn down a chance to win a $100 prize just because you might have to give back $20?
However there is always risk in the market. Even after a crash it could go down more. Any time you invest you need to be prepared for this. Always make sure your asset allocation is safe so you’ll be ok if the market goes down tomorrow.
The Canadian Couch Potato investment principle works efficiently as long as you accept the underlying conditions (understanding of your own risk tolerance, and acceptance of the long time scale required for probability to work its magic). Unfortunately, the varying degree of investor sophistication (including our own) may interfere with universal acceptance and practical application of this powerful principle.
It’s nice occasionally to read restatements in different words of the CCP principles by other readers just to make sure our own understanding is on track. @Jake and @Richard have expressed comments pretty much in line with what I would have said in response to AJ, so it’s a good feeling to see that my practical understanding of the CCP principle seems to be in line with other students of the art.
@Edward: Just curious — you make automatic cash deposits monthly or biweekly (depending on pay-check frequency) and you purchase and rebalance using the accumulated cash yearly (but not necessarily six-monthly unless the balance is far enough off), is that correct? In other words, you are prepared to wait 12 months, accumulating cash, without purchasing if the balance remains on track.
Sorry if you have addressed this already, but why did you choose to go with VAB over XBB in your model portfolio?
Can someone confirm after today’s budget and official annoucement of the TFSA limit of $10,000 I am able now to top it up now (today) to $10000 for year 2015 ?
Just read TFSA 10,000 limit is for this year so if u done 5500 already U can go another 4,500,
Check out financial post
@mike
Yes I’ve read that but the budget hasn’t actually passed. I’m not an expert on when things like this are official. I don’t want to put in the $4500 and then come to find out i did it too early and stung for over contribution.
hope @CCP can confirm for all of us..
TFSA they have majority so it will pass. If new govt in October liberal or NDP they might bring it back to 5500 but idought they will reverse what was done in 2015 or used the 4500 we put in this year as a carry forward to 2016.
I am putting the extra 4,500 now for my wifes account this week, just rounding up the money from the ING
@Worf: The cost of VAB is much lower than that of XBB.
@Jake: The budget is only hours old. I think it makes sense to wait a couple of days for the dust to settle and the details to be confirmed before making additional TFSA contributions.
Good day Spud
I have read your site (and Hallam), got the books, done some research, hooked myself up with a DBS retail account in Singapore, and a trading account, moved $$ to the trading account and now ready for the first buy.
Comments on my hybrid asset allocation would be greatly appreciated.
I have come up with a hybrid permanent/fundamental/swap with a twist line up.
For grounding, I am a Canadian living and still working in Thailand.
My proposed line up:
Horizon HXT 12.5% (Cdn equities, lower % as Cda small % of global mkt)
Horizon HXS 25% (US Equities)
Vanguard VSB 35% (Cda Gov. Short Term Bonds – ST as inflation to me has only one way to go)
iShare CIE 15% (International, lower % as I live and work in Thailand now)
Gold 12.5% (I plan to guy actual gold rather than a fund)
I am not sure if buying actual gold is more/less expensive than buying a gold fund – does anyone have a comment? I figure to buy gold as it is very liquid here and is useful even in emergencies where it would be readily available and easily converted into cash/goods/services if required, but still perform the same as the fund.
The mix represents the fact I live in Thailand and earn salary in bhat, so I lowered my international exposure to equities. Bonds I want to keep short term as inflation can only go one way in my mind now – the % is low given I am 50, but I do have a pension coming to me also so I feel the increased risk is mitigated by the fact I will have that guaranteed income stream coming.
I own my home in Thailand already and on top of what I have available to invest now (+$500K), I put away another $2k per month, and will do so as long as I keep working – likely another decade I would think (although i would cut that shorter if I can!!).
Again, all comments welcome
Isn’t the aggressive portfolio better because of dollar-cost averaging? There is a lot more chance that somebody invested regularly over the last 20 years than only once 20 years ago! I did a little excel simulation and it seems like a ‘rocky portfolio’ will be better even if the annualized return is the same.