Ryan Lewenza: The 5% Portfolio

January 28, 2015

2 minute read

The 5% Portfolio

by Ryan Lewenza, CFA, CMT, Private Client Strategist, Raymond James

• A common request we field from clients is the desire for a fixed 5% rate of return. In years past, this was a fairly easy deliverable as government and high-quality corporate bonds yielded enough to meet this investment objective. However, in the “new normal” where deleveraging, disinflation, anemic economic growth, and easy central bank policies have helped to drive bond yields to record lows, it is much more difficult to meet this objective.

• If it wasn’t hard enough to find attractive yields in the fixed income markets, the Bank of Canada (BoC) added to this dilemma, with the BoC surprising the markets this week by lowering the overnight rate by 25 bps to 0.75%.

• Examining the universe of Canadian fixed income securities, excluding high-yield which we remain cautious on, investors will be hard-pressed to find any higher-quality bonds yielding near the common investment objective of 5%. Clearly, an alternative approach is required to reach this level.

• To meet the 5% investment objective we would recommend investors consider creating a balanced portfolio with a mix of bonds and equities. Over the long run we believe Canadian equities can return 7 to 8%. For bond yields we see them rising, but remaining below the “normal” levels of the last few decades. This is based on the belief that the North American economy will see lower productivity gains and population growth, along with lower inflation levels. We see bonds yielding closer to 3% over the next decade. Using a 60/40 split, that would imply a potential 5.7% annual return over the next decade.

• Now this assumes market returns. Active investment management can lead to improved performance. Looking at our Guided Portfolios (Dividend and Moderate Bond portfolios) and using the same 60/40 split, they would have returned 11.4% annually since their inception in 2012.