It’s an understatement to say we live in uncertain times. Markets are holding steady as Canada transitions into a new world economic order but it’s anybody’s guess how that journey will impact long-term returns in our retirement portfolios.
We can control what we contribute but we can only try to control how those contributions grow and compound over decades.
Inflation is pushing fixed-income yields up right now. That’s good for investors looking for safe returns but there’s no guarantee those yields won’t be swallowed by a higher cost of living.
Fortunately, payments from Old Age Security (OAS), Canada Pension Plan (CPP) and the dwindling number of defined-benefit pensions are indexed to inflation.
Unfortunately, most investments in more popular defined-contribution pensions, Registered Retirement Savings Plans (RRSP) and Tax-Free Savings Accounts (TFSA) are blowing in the wind.
Without inflation, investment advisers say 4 to 6 per cent average annual returns are realistic targets over the long term.
There will likely be negative and double-digit years, balance sizes will change over time and it depends on an individual’s retirement goals and tolerance for risk.
Using the Rule of 72 as a return benchmark
There are many online tools to calculate the average annual rate of return needed to reach your retirement goals. A qualified adviser can help.
One simple way to get a ballpark figure of the rate of return needed for an investment portfolio to double or quadruple in value over a certain period of time is through the Rule of 72. It’s a mathematical formula that divides 72 by the annual rate of return.
As examples, the Rule of 72 estimates that $1 invested at an annual fixed return of 10 per cent would take 7.2 years (72 divided by 10 = 7.2) to grow to $2.
Put another way; to double your money in six years you would need a 12 per cent rate of return.
The Rule of 72 is most accurate for rates of return of between 5 and 10 per cent.
Investopedia has a more comprehensive breakdown.
Balancing risk and returns
A qualified adviser can also help target realistic returns for individual clients by understanding their retirement goals and tolerance for risk.
As a general rule, the potential for big returns is greater when the investor takes greater risk. Investing over the long term brings an opportunity to strike a balance between risk and returns.
The goal is to manage risk without sacrificing rewards by diversifying investments across equity sectors and geographic regions, and fixed-income such as bonds.
As we near retirement, risk and reward are ratcheted down to ensure we hang on to what we have.
As mentioned, inflation can take a big bite out of returns and that’s why it’s important to select investments that can best absorb the higher cost of living.
Risk-free return boosters
One way to lock in solid returns and leave more of your tax dollars compounding in your portfolio is through an effective tax strategy.
A good adviser should know the basics but do-it-yourselfers can defer paying tax on their investments through an RRSP. The plan allows contributions to grow tax-free in just about any kind of investment until the funds are withdrawn, ideally at a low marginal rate in retirement.
To avoid high taxes if your RRSP investments grow too much, contributions can be diverted to a TFSA. Contributions can not be deducted from income like an RRSP, but any funds withdrawn will escape the claw of the Canada Revenue Agency.
Another risk-free way to boost returns is by keeping investment fees low. Generating consistent returns, on target, requires professional management but there is point when fees become a drain.
A money manager with a 2 per cent fee must generate 8 per cent to return 6 per cent to you, as an example.
If you pay fees exceeding 2 per cent on your entire portfolio, it might be time to shop around.
