Since when is a 6.8% return unreasonable? - MoneySense

Since when is a 6.8% return unreasonable?

Comments on a recent Toronto Star story are a perfect example of misplaced expectations held by many investors.

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Two Toronto Star writers are probably shaking their heads at the outrage one of their articles elicited yesterday.

The Star’s Moneyville site features an article based on a press release from TD Canada Trust, illustrating the virtues of investing early in life.

In a nutshell, it says that if you start investing $100 a month at age 25 and increase your contributions as you age, you’ll end up a millionaire by the time you retire.

At first glance I had no problem with the article. You save money — on an increasing scale — for 40 years, and wake up wealthy on your 65th birthday. Time to bust out the champagne!

But then I noticed this line:
This chart assumes contributions are directed into an RRSP account, benefiting from the tax deferred growth and earning a 6.8% rate of return per year, compounded monthly.

Readers, to put it mildly, did not like this. The comments section lit up like it was Chinese New Year in Shanghai.

“6.8% rate is not realistic,” ripped one reader. “The Toronto Star should be embarrassed for putting this forward as ‘news’.”

“Who is getting 6.8% or even 5% interest?” asked another. “I want to know what financial outlet is giving that kind of interest on GICs, RRSPs, TFSAs? It is not true.”

And finally, “Anyone with a [sic] some sort of common sense knows this is next to impossible which is the same as winning the lottery.”

6.8% … Seems kind of high, right? As it turns out, the answer is yes, and no.

With interest rates currently somewhere between “very low” and “why even bother having an interest rate?” investment vehicles like savings accounts, money markets and GICs don’t offer a whole lot of growth. Bonds are slightly better, but are wobbly these days thanks to European and Middle Eastern governments either spending like drunken sailors or reaping the dubious rewards from decades of authoritarian rule. Stocks have been on fire as of late, but we all know that they too, can end up in tears.

However, from a historical perspective 6.8% is completely within the realm of possibility. According to our Canadian Couch Potato investing expert Dan Bortolotti, global stock markets have delivered returns of 9%-10% annualized over the past 30 years. Even bond markets have returned 9%, although current conditions make it unlikely to repeat that feat anytime soon. However, a balanced portfolio can reasonably be expected to return 6% to 7% annualized.

From what I can see, people are still suffering from myopia due to the legacy of the financial crisis. Markets took a big hit three years ago. Economies went into recession. Interest rates plunged and investment returns of all types followed suit.

But it wasn’t always this way. Map out investment returns over 30 or 40 years and TD’s math makes sense, even with calamitous events such as what we saw in ’08.

Despite the din from hysterical naysayers, the point of the article is sound. Investing works best if you start early, choose investments wisely and increase your contributions whenever you can. A return of 6.8% may sound high to those who stare at their feet, but if they lifted their gaze to the horizon they would see a much different picture.

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