With the global investment environment characterized by extremely low bond yields, and equity returns well below historical averages, it's a difficult and at times confusing challenge for investors who want to determine what they should expect from future returns.
That's where the Toronto-based Financial Planning Standards Council (FPSC) has stepped up, with the latest annual edition of its Projection Assumption Guidelines.
Drawing from data sources such as the Canada Pension Plan, Quebec Pension Plan and the Willis Towers Watson portfolio-manager survey, the 12-page document was developed by an independent committee of actuarial and certified financial planner (CFP) professionals.
First published in 2009 by the Institut québécois de planification financière (IQPF), FPSC's sister organization, and produced jointly in 2015, the updated 2016 guidelines indicate annual inflation of 2.1%, short term fixed-income returns of 3%, long-term fixed income returns of 4%, Canadian equity returns of 6.4%, foreign developed-market equity returns of 6.8% and emerging-markets equity returns of 7.7%.
"When the national guidelines were first produced in 2015, we got beaten up quite vigorously because many felt our assumptions were too low. We got comments like, 'How can I go to my clients and say the best return I can provide is 3.3%?'", says William Jack, a Toronto-based actuary who heads William D. Jack & Associates Inc. and participated in the development of the guidelines. "But the interesting thing is the feedback from the 2016 guidelines is that our expectations for 4% fixed-income returns, for example, are too high. We invite criticism and will make changes as data sources change."
In 2015, rate-of-return assumptions were slightly lower: inflation was 2%, short- term fixed-income returns were 2.9%, long-term fixed income 3.9% and Canadian equities 6.3%. There were no projections for foreign equities.
This year's edition was driven in large part by consultations with industry firms and CFP professionals across the country, who sought to broaden the 2015 guidelines to include return assumptions for foreign developed markets and emerging markets.
"It was also important that the guidelines be completely transparent. In other words the committee wanted to ensure that users of the guidelines could replicate the guidelines should they wish," says Joan Yudelson, FPSC's vice-president, professional practice.
"For that reason, the guidelines are based on publicly available data sources, such as the CPP and 50-year historical data." Yudelson adds: "Investors can have confidence working with financial planners who base their assumptions on objective, reliable sources, versus saying, ‘Let's look at what the market has done over the past couple of years.'"
The FPSC guidelines are intended for medium and long-term financial projections, Yudelson notes, in order to support longer-term planning for retirement, for instance, or a child's education. "If a financial planner is projecting for the next three years, for a client invested in a guaranteed investment certificate (GIC), the guidelines would be less relevant. In that case, the planner would simply use the GIC rates of return."
More important, Yudelson argues, the guidelines are a kind of "stake in the ground" that advisors can be confident in relying upon. Nevertheless, financial planners may deviate from the guidelines where they may have reason to. For instance, they may expect the inflation rate for education costs may differ from the 2.1% guideline.
"The important point is that financial planners can support their assumptions. It's no different than any other practice that financial planners engage in," says Yudelson. "Whether it's using assumption guidelines or advising on leveraged investments or advising on a strategy to best save for retirement or best protect their families, the planners must always document their rationale and be prepared to defend it."
From his perspective, actuary William Jack works with many clients aged 60 to 67 and builds financial models that project future expenses and incomes. "When it comes to longevity, I am very reluctant to use a life expectancy of less than 90, unless there is some medical condition," he says.
Moreover, he encourages clients to use an overall portfolio rate of return between 4% and 6%, net of expenses. "I'd say to them, 'Below 4%, means being more conservative, which forces you to save more money, more than what you may actually need. These forced savings reduce the amount available to support your lifestyle,'" says Jack. "Above 6%, and being too aggressive, exposes you to the risk of outliving your money -- if you cannot realize that return."
The guidelines are a way of communicating to clients that a planner is not just pulling numbers out of the air or expressing his/her own biases, says Ross McShane, director of financial planning at Ottawa-based McLarty Wealth Management. "Rather, the planner is relying on a national financial-planning council that has called on a variety of resources. If I was the client, I'd like the fact that there was a discipline in place and we're relying on some very trustworthy sources. I want to know that the planner spent some time doing research to provide me with the information I'm looking for."
Using these guidelines ought to strengthen the client-planner relationship, McShane believes. "The client will think, 'This person is relying on reputable sources for their information.' This promotes greater trust and demonstrates that the planner is paying more attention to detail and taking greater care."
Using rates of return that are within the FPSC guidelines will have few if any implications for clients, argues McShane, whose 4% annual return (net of fees) for balanced portfolios is almost identical to the FPSC guidelines. But there may be situations where rate-of-return assumptions, after fees, are not in line with the guidelines.
"As clients become more informed, they will challenge the advisor and say, 'I'm not confident that you can make X% net of fees.' It's up to the advisor to demonstrate that he can, but based on a certain asset mix. These guidelines are there to provide that kind of assurance and support on how they come up with a rate-of-return assumption."
Scott McKenzie, senior vice-president at Toronto-based T.E. Wealth, notes that his firm had been revising its own rate-of-return projections downward since the 2008 financial crisis. Its software program that projects future returns is very close to the FPSC guidelines. And, in tandem with lowered expectations, the guidelines are working.
"Before 2008, clients came in expecting they might get a 10% return. But 2008 was a wake-up call," says McKenzie, adding that aggressive investors had the most difficulty accepting the new reality of lower returns.
"It's not been a big adjustment for most of our clients," McKenzie says. "An educated client is more understanding of changes in the marketplace. Your job is making sure your clients are up-to-date on the latest information, whether it's expectations of the rates of return or what's happening in their portfolios."
