How Have You Fared Since the Crisis?

07/30/2012 10:45 am EST


Rob Carrick

Columnist, The Globe and Mail

To analyze returns, let's use some model portfolios that resemble what you and other investors hold, writes Rob Carrick, reporter and columnist for The Globe and Mail.

Five years have passed since the global financial crisis started beating on your investment portfolio. How badly have you been hurt?

If you don't know, find out using this edition of the Portfolio Strategy column. It's designed to help investors take stock of the ups and downs since August 2007, when the crisis began quietly with the realization that trouble lay ahead in complex investments based on US mortgage debt.

The past five years have been so rough for investors that breaking even has to be considered a satisfactory outcome for many. An average annual return of 1% to 2% for a balanced portfolio is quite a good result.

To analyze returns over the past five years, let's use some model portfolios that resemble what you and other investors hold. A 60:40 mix of stocks and bonds, respectively, is pretty common for mainstream investors, so let's start with that. Then, let's add a more conservative 40:60 blend of stocks and bonds and an aggressive portfolio with an 80:20 mix.

Six different components will be used in building our model portfolios, each represented here by a widely followed benchmark index:

  • Cash: Treasury bill rates will be used here, as tracked by the DEX Treasury Bills index
  • Bonds: The DEX Universe Bond Index is used here because it includes both government and high-grade corporate bonds (in a rough 70:30 mix), and thus gives you all-in-one exposure to the bond market.
  • Canadian stocks: The S&P/TSX composite index will be our benchmark; as with all stock returns referenced here, this is a total return number that includes both share price changes and dividends.
  • US stocks: The S&P 500 index is the benchmark here, calculated in Canadian dollars.
  • International stocks: The MSCI Europe Australasia Far East (EAFE) Index is used here, again in Canadian dollars.
  • Emerging markets: The benchmark is the MSCI Emerging Markets Index; this category is used as a proxy for any small sector weighting in a portfolio that can provide the potential for greater returns (and extra risk); Canadian dollar returns are used.

Here's an example of how to use the benchmark returns to find your own results. If you have 40% of your portfolio in Canadian stocks, multiply 0.40 (that's 40/100, or 40%) by the 0.74% annualized loss for the S&P/TSX composite index over the past five years. Do a similar calculation for each component of your portfolio and then total up the results to get your gross return before fees.

For real-world results, you have to take benchmark returns and reduce them by the fees and commissions you pay. If you have an advisor who uses mutual funds, you're likely paying something in the area of 2% in fees. So if you're in the standard 60:40 portfolio, your annual 1.51% benchmark return over the past five years could become a loss of 0.49%.

With a fee-based advisor (who charges a set percentage of your account value), you might be closer to 1.5% if he or she uses exchange traded funds to build portfolios. Fee-based accounts of stocks and bonds might cost in the 1% range.

Do-it-yourselfers who hold stocks and bonds and don't trade much might need to reduce their returns only a bit to reflect the impact of trading commissions. ETF users who manage their own investments should deduct roughly 0.5 of a percentage point if they use only basic funds covering major indexes, and 0.75 of a point if they mix in some exotica.

The thin returns of the past five years are the best lesson ever on the importance of minding the fees and commissions you pay to invest. Think not only about the absolute level of fees you pay, but also the value you're getting.

Fees that bring you lots of help from an advisor on matters such as retirement, taxes, retirement and debt are worth it, even as they eat into your returns. Fees paid to what amounts to an investment salesperson are a waste.

The investment industry is for the most part awful about providing detailed returns for client portfolios, so don't be surprised if you can't find the overall portfolio return numbers you need for this exercise.

To work around this, take the components of your portfolio and analyze them individually. If you have an equity mutual fund or ETF, compare its returns to the S&P 500. If you have a diversified bond fund, use the DEX Universe Bond Index.

ETFs are index trackers, so they should more or less give you the return of the underlying index minus the management expense ratio. With their higher MERs, mutual funds often underperform benchmark indexes. That's life with funds.

If your portfolio has performed close to the benchmark or better on an after-fee basis over the past five years, you've done well. Your returns may sound weak on an absolute basis, but put in context they have to be seen as acceptable.

Returns that lag the benchmark significantly demand further investigation to see whether your portfolio has too much stock market exposure. Also, compare what you're paying in fees and what you're getting in service.

And now for a warning about those five-year numbers: They're strictly for looking back and measuring past returns. Do not use them as a guide for what's ahead because they'll mislead you.

There is virtually no chance that bonds will give you average returns of almost 7% over the next five years, as they have since 2007. Central banks around the world chopped interest rates lower at a furious rate as the crisis erupted in September 2008, and that accounts for strong bond returns.

Even if rates go a little lower to help stabilize the global economy, there's simply not enough juice left to crank out returns of almost 7% for bond funds.

The negative returns for the stock market over the past five years might just be repeated—who knows? But it's more likely we'll see a solid run-up in the next few years.

Remember, the 20-year average return for the S&P/TSX composite is 8.71%, even after absorbing big market plunges in 1998, 2001-2002, and 2008. This suggests your portfolio will recover from the beating of the past five years.
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