Debunking Magic Investment Promises

Last week CBC Marketplace published a report and accompanying video of their hidden camera work at the big 5 Canadian banks exposing some of the heinous sales practices they saw.? If you haven’t watched the video yet – scroll down to the comment section.

I wrote last week about the claims made that people shouldn’t pay off their credit card debt and invest the money in their mutual funds instead, which can be read here.

Today I want to break down another claim made in the piece: ‘the average interest you get is at least 10%’. ?‘At least’ sets a floor value guarantee – it sounds too good to be true, continue reading.

In this piece, I will break down:

1. What you can realistically expect from your investments.
2. Show why a promised 10% return is misleading and dangerous.
3. What the bank advisor should have said.

The goal is to help you the reader be better equipped to:

• Help you spot unrealistic promises.
• Understand realistic expectations for investment returns.
• Empower you with knowledge to make more informed financial decisions.

Understanding Realistic Returns?

The easiest thing a charlatan can do to make a sale in investment products is to over promise.? When people feel cheated – the story usually starts with ‘but the advisor said ________’.

Most introductory meetings I have had throughout my career have included a question like ‘what kind of returns have your clients been getting’.?

Advisors hear this question all the time, and it doesn’t take a well tuned ear to understand the real question behind it – internally, they’re asking ‘what kind of returns can we expect?’

As a practitioner, this is a slippery slope.? There are two forces at play –

1. What the investor wants to hear (some form of great returns with lower risk), and
2. What they want to feel (‘will my money will be safe and provide us with the life we want to live’).?

How we answer this question distinguishes whether we are in the business of sales or helping clients achieve their goals.

Two ways to answer the question:

We could answer the exact question they’re asking – ‘what kind of returns have our clients been getting’:

“Over the last 10 years, clients have averaged __%”.

While this may be factually correct, it ignores the ‘past performance is not indicative of future performance’ part entirely.?

Take for example, the last 4 decades for the US total market.?

The 2010s have been a good time to be an investor – oversimplified version – inflation and interest rates were low, relative geopolitical stability, and asset prices rose as a result.

Contrast that with the 2000s, the ‘lost decade in US equities’ where the US market was flat.

Just as it would have been wrong to expect the US to remain flat through the 2010s, it is equally ignorant to expect the good fortune of the 2010s to continue indefinitely.? ??

TIP: If someone answers with past performance – have your radar on high alert.? Be sure to follow up with ‘and what do you expect in the future’ to give the advisor no doubt as to what the underlying questions really are and give clarification.

Alternatively, we can answer the underlying question from the standpoint of research, valid expectations, and help give clients the tools and information they need to achieve their financial goals, which I will outline in this post.

Let’s first address the itch we all want scratched in some form or another – how can we get high investment returns with lower volatility?

It doesn’t really exist, if it did, someone would be doing it.

There are no magic beans out there.

The presumption must always be that the price of assets (stocks, bonds, currencies, etc.) reflect all information publicly available.? This is the efficient market hypothesis, which is beyond the scope of this post – but the conclusions are straightforward – it is nearly impossible to beat the market.

Investing with me, or anyone else will not help you beat the market on a risk adjusted basis.

Past performance has no bearing on future performance.

What are reasonable returns?

The advisor should not be saying ‘what I am hoping for’ returns – everyone wants the results to be higher I’m sure – what we’re looking for are reasonable returns, the kind that families can plan around.

Professional standards are that should not be making up number.? I rely on Ortec Finance’s work, along with FP Canada, or PWL’s market expectations [all can be found in the comments below]– which are all roughly in line.? For this piece, I will use only Ortec’s figures for consistency purposes, and it is also the data set I use in my practice for risk and return expectations.

TIP: You should never hear someone extrapolating past performance into the future, using a hunch, or trying to impress anyone with false expectations.

The following represents five generic asset allocation models, their long-term return expectations, and the annual volatility expected (as measured by standard deviation).

Each of the five generic portfolios with different allocations to risky assets in the top section.

Below, you will see the long-term return projections (I’ll expand on this below, factoring in the fees paid).

Finally, the standard deviation, or expected annual volatility of those returns.

Quick refresher from high school math – in a normal distribution, one standard deviation in either direction of the average represents 68% of expected observations, 2 standard deviations are 95%, and 3 are 99.7%.

For example – using the data, a balanced portfolio would expect to have return ranges at different likelihoods of 1-year outcomes.

For the Balanced Portfolio:

• In a ‘normal year’ (arbitrarily defined as 68% of the time) it would be expected that the returns in the portfolio would be between -6.09% and 16.37% by combining the two middle rows.
• On the positive side, 13.5% of the time, the returns would fall between 16.37% and 27.6%, and in 2.5% of occurrences, the returns would be higher than 27.6%.
• On the negative side, 13.5% of the time, the returns would fall between -6.09% and -17.32%, and in 2.5% of occurrences, the expected returns would be lower than negative 17.32%.

Quantifying the Banker’s ‘at least 10%’ claim:

In the context of the initial question – how much of a ‘guarantee’ is a 10% or greater return from these portfolios – this can be calculated using probability tables/excel – to solve how often each of the portfolios would be expected to have returns higher than 10%.

From this, 2 things are evident –

• First that a ‘guaranteed’ rate of return of 10% comes with anything but a guarantee with failing to achieve this being fully expected far more often than not.
• Second - in any asset allocation – these rates of return exist, but are far from normal or expected.

Out of curiosity, I wanted to know the equally likely adverse returns (so the same distance from the average to 10% going the other way):

This is likely not as compelling as a 10% return, and wouldn’t push the sales figures much, would it?? Yet it is an equally likely occurrence in a 1-year period.

What are reasonable returns? What should that bank advisor have said instead?

1. Reasonable returns are on a spectrum, and guarantees are beyond disingenuous.

Before the costs of investing, the Balanced Portfolio noted above would have an expected long-term return of 5.14% - the short-term however could be anything between negative 17.23% to positive 27.6% when removing the furthest tail risk (while acknowledging its possibility).

Your advisor should outline this during the planning stages while they are reviewing your risk profile (and no, a risk profile is not a 20 question multiple choice).

We live in a world where nobody can control the investment outcomes – we are at the whim of whatever happens.? Having a well communicated risk strategy/profile is important.

2. Acknowledge the fees, be honest about the investments.

The overwhelming majority of mutual funds have underperformed their benchmark after fees.? This is a trend we can expect to continue.? If I add in a 1.5% fee to the investment at the bank (low by their standards, which is a topic for another day), and re-run the success rate of achieving a 10% minimal return, we get the following:

Again, the equal likelihood of returns in the opposite direction, after fees would be:

3. Investing is one of the final steps in the order.

A topic for another time – making an investment decision, cannot be made without proper context.? A 45-minute meeting at the branch and somehow making an investment decision means that the advisor cannot possibly have diagnosed the situation properly and developed a justifiable reason for the investment implementation.? Selecting investments comes in the late stages of financial planning, and has no business being in a 45-minute meeting.

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Key Takeaways:

• High return promises don’t match reality.
• Realistic and justified return expectations are crucial for effective planning.
• Investment decisions should be made within the context of your overall financial goals.