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Kevin Greenard: The impact of variable returns

The variability of investment returns can have a material impact in the early years of investing. Over time, the variability of returns is smoothed out.

The variability of investment returns can have a material impact in the early years of investing. Over time, the variability of returns is smoothed out. There are methods and strategies to reduce the variability for investors who have cash and want to get these funds invested.

Over the years, we have received hundreds of calls from individuals who have sold a business, home, or received an inheritance. All have the same desire to protect the capital and get a rate of return.

Timing in the short-term

For the most part, the timing of when funds are received by clients may or may not be ideal with respect to where the equity market cycle is positioned — that part can not always be controlled. However, the timing of getting funds invested can be controlled and managed by a Portfolio Manager.

Variable returns in the short-term

To see how both positive and negative years in the equity markets impacts your portfolio in the short term, we have developed the Greenard Group Variability Chart, which we have published multiple times over the years.

The table below shows how the first-year actual investment returns effect the required average annual returns to reach annual short-term growth targets of six and eight per cent.

Greenard Group Variability Chart

 

 

Time horizon to meet your annual growth target *

Annual Growth Target

First Year Actual Returns

1

2

3

4

5

6

7

8

9

 6%

15%

(2.3)

1.8

3.2

3.9

4.3

4.6

4.8

4.9

5.0

 6%

5%

7.0

6.5

6.3

6.3

6.2

6.2

6.1

6.1

6.1

 6%

-5%

18.3

12.0

9.9

8.9

8.3

8.0

7.7

7.5

7.3

 6%

-15%

32.2

18.4

14.1

12.0

10.8

10.0

9.4

9.0

8.6

8% 

15%

1.4

4.7

5.8

6.3

6.7

6.9

7.0

7.2

7.2

8% 

5%

11.9

9.5

9.0

8.8

8.6

8.5

8.4

8.4

8.3

8% 

-5%

22.8

15.2

12.7

11.5

10.8

10.3

10.0

9.7

9.6

8% 

-15%

37.2

21.7

17.0

14.7

13.3

12.4

11.8

11.3

10.9

* Required average annual return to reach stated annual growth target (with different outcomes)

First year of investing

An investor who began investing in early 2019 may have a significantly different outcome than an investor who began investing at the beginning of this year.

When we have new clients with a lump sum to invest, we communicate the importance of reducing market risk. Market risk is simply the risk of the market pulling back — it is not specific to any one security. With the rise in exchange-traded funds and mutual funds, when investors are selling, all constituents of these structured investments will decline.

Components to reduce market risk

The strategy of how to reduce market risk is dependent on many components. The three main components include:

- Our professional opinion on where we are in the market cycle;

- Client’s net worth, cash flow needs, and risk tolerance; and

- Age, time horizon, and past investment experience.

The Greenard Group approach is very much customized to each client. Below we have provided a few examples.

Example 1: Sandra Smith

At the end of 2020, we received a call from Sandra. She was referred to us by a friend who is a client of ours. Sadly, she lost her husband during the year, and he had been handling the finances. In addition, she received $750,000 as a lump sum payout from an insurance company.

Assessing the three main components above:

- Sandra came to see us at the end of 2020, when markets were at historic highs.

- Net worth was high: Excluding principal residence, the investable assets are $1.3 million.

- Other income sources are low, cash flow needs are high, and risk tolerance is medium.

- Sandra is 59, would like to plan to age 95, and has limited investment knowledge.

The components mapped out for Sandra involved preparing a financial plan, ensuring she prepared a summary of her cash flow needs/budget, focusing on low beta dividend paying stocks, and getting the funds invested over time.

On the first meeting, we invested only 25 per cent of the cash to get the baseline core names in the model portfolio and to start receiving dividend income. We also mapped out a plan of what the portfolio will look like once fully invested. As Portfolio Managers, we have the discretion to react quickly if market opportunities present themselves.

Example 2: Heather and Thomas White

Heather and Thomas sold their house for $1.3 million in December 2021 to capitalize on the hot housing market. They have decided to rent and not buy back into the real estate market. Heather and Thomas already have $1.0 million invested in non-registered, TFSA, and RRIF accounts.

Assessing the three main components above:

- Heather and Thomas came to see us in December 2021 — markets were once again at an all-time high.

- Net worth was high, and the investable assets are $2.3 million.

- Other income sources are moderate (registered pension plan, CCP and OAS), and cash flow needs are moderate to high as they need cash flow to pay rent and to travel.

- They have more than 20 years of investment experience, have high investment knowledge, and a moderate risk tolerance.

- Heather and Thomas are both 78 and would like to plan for at least one of them living to age 95.

The components mapped out for Heather and Thomas involved updating their retirement financial plan for the recent sale of the house.

The plan required us to send $10,000 automatically every month from their investment account to their bank account. We set aside $240,000 into a special money market ear-marked for their cash flow needs for the next two years — we refer to this as the wedge.

With the residual amount, we integrated this cash with the existing investments, which involved restructuring the placement of the investments and position size.

The discussions also focused on tax efficiency and generating ongoing income to replenish the wedge for the monthly draw. Given that markets were at an all time high, and they had an existing portfolio, we invested only 25 per cent of the lump sum deposit.

We also discussed that if the markets pull back that we would view this as an opportunity to get the remaining funds invested. Within six months, we were able to get 75 per cent of the cash invested.

Example 3: John Johnston

John was a dentist who recently sold his dental practice for $2 million. He is planning to work for another three years. His other investments are primarily tied up into real estate. John has moderate knowledge of financial investments.

Assessing the three main components above:

- John came to see us in June 2022 — markets had pulled back substantially.

- Net worth was high: Excluding principal residence, the investable assets are $2 million.

- Other income sources are high, cash flow needs are none (from the portfolio for three years), and John has a high risk tolerance.

- John is 54, would like to plan to age 90, and has moderate investment knowledge.

The components mapped out for John involved preparing a retirement financial plan. John is planning to make further deposits into the accounts over the next three years, does not require any cash flow from the investments, and would like to focus on getting growth.

On the first meeting, given where we were in the market cycle, we invested 50 per cent of the cash to get the baseline core names in the model portfolio, and to position the portfolio for growth. We also mapped out a plan of what the portfolio will look like once fully invested, which we anticipate will be within the next six months.

As Portfolio Managers, we have the discretion to react quickly if market opportunities present themselves. John is going to make substantial deposits that will also need to be invested over time. In addition to his professional revenue, he has rental income that will subsidize his cash flow needs.

Kevin Greenard CPA CA FMA CFP CIM is a Senior Wealth Advisor and Portfolio Manager, Wealth Management, with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138, email Greenard.Group@scotiawealth.com, or visit greenardgroup.com.