Many Canadians' retirement plans in dire need of reality check

Many Canadians could end up with a lot less money for retirement than they expect because their investment plans are based on projected rates of return that are now far out of step with reality.

The expected rate of return is a crucial piece of any retirement plan, because it sets the expectation for how much a portfolio will grow and what it will ultimately be worth when a person is ready to retire.

There was a time not so very long ago that many financial advisers were confidently projecting that a well-diversified portfolio made up of a mix of equities and fixed income investments could comfortably earn a long-term average of seven to eight per cent a year.

That projection was based, in part, on what stock and bond markets had managed to return over the long haul in decades past. The benchmark index of the TSX, for instance produced an average annual return of 9.5 per cent over the 40 years ending in July 2011. Fixed income investments had also generally fared well over longer periods, as bond prices rise when interest rates fall – as they did for much of the 30 years after 1980.

But as Canadians head into 2012, the world economy is wrestling with an outlook that the head of the International Monetary Fund has described as "quite gloomy." Interest rates are already at rock-bottom and can't fall much further. Long-term bond yields are at historic lows. Everybody seems to be waving "caution" flags.

Many advisers are now saying it's time for investors to do much the same thing when projecting long-term returns going forward. And that could have a major impact on how much net worth many Canadians will have to look forward to in their golden years.

"It would be unwise to assume an eight per cent average over the next 15 to 20 years," says Warren MacKenzie of Toronto-based Weigh House Investor Services. "I think we're in for some tough times."

Making projections is a fundamental part of retirement planning. While you can't know for certain how your stocks, bonds, mutual funds and other investments will do over the years or decades until you need to start dipping into them, you have to make some educated guesses to do any planning.

'It would be unwise to assume an eight per cent average [return] over the next 15 to 20 years. I think we're in for some tough times.'—Warren MacKenzie, Weigh House Investor Services

If you don't make certain assumptions about portfolio growth, you'll have no way of figuring out if you have a hope of reaching your financial goals.

Service Canada's comprehensive online retirement calculator, for instance, allows you to choose an estimated portfolio return of anywhere from two per cent to 20 per cent. The default return – the one the calculator will use unless you change it – is currently seven per cent.

Depending on what expected return you choose to plug into a calculator, the results it spits out can mean the difference between being told that, yes, you'll be able to retire when you hoped to … or no, you'll have to work an extra 10 years.

So when you plug in your best guess, what return should you pick? Eight per cent? Seven? Six?

Try five per cent – at most.

That's what some experts are now saying is the best to realistically expect over the long term for a balanced portfolio, based on the current economic turmoil and the dubious outlook for the coming years.

"In the plans that I'm doing now, I'm projecting 4.75 per cent to 5.00 per cent," says MacKenzie of Weigh House Investor Services.

The message for investors is now hope for the best, but plan for the less-than-best.

A similar bit of advice comes from Justin Bender, a Chartered Financial Analyst and portfolio manager at PWL Capital. He says he still sees "unrealistic portfolio return expectations" among clients of as much as 12 per cent for balanced portfolios.

Bender used research from Credit Suisse about projected real equity and fixed income returns going forward, and then added his own assumptions about inflation rates and real return bond yields. He came up with nominal expected rates of return of 6.0 to 6.5 per cent for global equities and 4.0 per cent for bonds. His conclusion?

'Financial planners using more than a 4 per cent to 5 per cent rate of return for their projections (after fees) may be overstating the return that their clients can reasonably expect.'—Justin Bender, PWL Capital

"Financial planners using more than a 4 per cent to 5 per cent rate of return for their projections (after fees) may be overstating the return that their clients can reasonably expect."

The old 3-6-9 assumptions that many financial planners used to use – projecting three per cent inflation, six per cent fixed income returns, and nine per cent equity returns – are being abandoned.

"Depending on the client, I've been using five to six per cent [for a balanced portfolio] for the last three years," says Julie Leefe, a Registered Financial Planner at Prisma Financial Planning in Oakbank, Man. "I will go lower than five if the client is closer to retirement."

Paul Wilson, a Certified Financial Planner at JPW Insurance Retirement Investments in Halifax, also cautions not to expect double-digit returns going forward. "If you can do four percentage points better than inflation, that's pretty good," he says.

The bottom line is that it may now simply be too risky to use historical performance data for retirement planning projections. The boiler-plate warning on many investment documents that "past performance is not a guarantee of future returns" has never been more relevant.

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Check Out Of Starwood Before Off-Balance Sheet Loophole Closes

Account­ing rules pro­vide large loop­holes for asset-inten­sive busi­nesses, and the off-balance sheet oper­at­ing lease loop­hole is one of the biggest.

By exploit­ing the off-balance sheet oper­at­ing lease loop­hole, Star­wood Hotels & Resorts Worldwide was able to omit nearly $1 bil­lion in debt from its balance sheet in 2010, $200 mil­lion (20% of the total) of which was added in 2010.

As shown in the fig­ure below, Starwood’s reported net income diverges rather sharply from the eco­nomic earn­ings of the business in its most recent fiscal year.

In addi­tion to over­stat­ing account­ing earn­ings, the large amount of hidden debt cre­ates two red flags for investors:

Free cash flows are about $200 mil­lion worse than they appearReported debt and lever­age are under­stated by nearly $1 billion

I always pair my analy­sis of the true cash flows of a busi­ness with val­u­a­tion of the stocks. It is pos­si­ble for a com­pany to be ter­ri­bly unprof­itable but a good stock if the future cash flow expec­ta­tion reflected in its val­u­a­tion are low enough.

To jus­tify its cur­rent price ~$57, Star­wood would have to grow its after-tax cash flow (NOPAT) by over 20% compounded annu­ally for 11 years. Those are some high expectations…not just the high level of growth but also the long dura­tion of expected growth.

The high­est level of top-line growth achieved by Star­wood in the last 10 years is 17% in 2002. Only once in the last 10 years has the com­pany gen­er­ated con­sec­u­tive years of double-digit rev­enue growth (16% and 11% from 2005 to 2006).

A stock price val­u­a­tion that implies 11 con­sec­u­tive years of 20% growth in NOPAT is too high for most com­pa­nies, espe­cially a hotel in a global econ­omy that is expected to be rather weak for the fore­see­able future.

With no future profit growth, the value of Starwood’s stock is closer to $2 per share. Though I do not nec­es­sar­ily expect Star­wood will achieve no future profit growth, I think the no-growth value pro­vides impor­tant per­spec­tive on how much growth is priced into the stock and how much risk investors take by hold­ing it.

The fig­ure below sug­gests that investors in HOT’s stock could be in for some trou­ble if his­tory repeats itself. The last time Starwood’s reported earn­ings over­stated its eco­nomic earn­ings by more than 15%, the stock fell over 70%, from the mid $60s to under $20 per share.

I also expect that Starwood’s earn­ings over­state­ment will revert to more nor­mal lev­els because com­pa­nies can only bend the rules so much before break­ing them. In addi­tion, Starwood’s understate­ment of leverage will no longer be possible when FASB is expected to change the accounting rules and force companies to report operating lease liabilities on balance-sheet. This change is expected to occur in the next year or so, and it will close the off-balance sheet debt loop­hole.

Star­wood is one July’s most dan­ger­ous stocks and gets my “very dan­ger­ous” risk/reward rat­ing. There is lots of down­side risk given the mis­lead­ing earn­ings while there is lit­tle upside reward given the already-rich expec­ta­tions embed­ded in the stock price. More details on my rat­ing and a free report on HOT are here.

In a busi­ness where investors make money by buy­ing stocks with low expec­ta­tions rel­a­tive to their future poten­tial, HOT fits the pro­file of a great stock to short or sell.

Special Offer: Drink up huge profits with Jim Oberweis.  He’s the guy who had subscribers into Baidu at $8 and who rode Hansen Natural (maker of Monster drinks) for a 1,200% gain. Click here for four stocks to buy and sell now…in the Oberweis Report.

I also rec­om­mend sell­ing the fol­low­ing ETFs because of their “dan­ger­ous” rat­ing and expo­sure to HOT. Note the per­centile ranks show where each ETF stands among the 375+ U.S. Equity ETFs we cover, where 100% cor­re­sponds to the highest-rating.

Pow­er­Shares S&P 500 High Beta Port­fo­lio (SPHB) – 8th percentileiShares Morn­ingstar Mid Growth Index Fund (JKH) – 33rd percentileVan­guard Mid-Cap Growth ETF  (VOT) – 34th percentile

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Check out-of-Starwood loophole closed before off-balance sheet

Accounting rules provide for asset-Inten­sive-Busi­nesses large Loop­holes, and the off-balance sheet oper­at­ing leasing Loop­hole is one of the largest.

By the off-balance sheet leasing Loop­hole oper­at­ing exploit­ing, was Star­wood around the world almost missed hotels & resorts $1 Bil­lion in debt from its balance sheet in 2010, that the $200 million (20% of the total) of which in the year 2010 has been added.

As shown in the Fig­ure below reported star page result rather strongly of a bankruptcy of Earn­ings of business in the last financial year differs.

In Additionally to over­stat­ing accounting Earn­ings cre­ates the large amount of hidden debt two red flags for investors:

Free cash flow are about 200 million $ AppearReported are worse than they debt and leverage under­stated of almost a billion US$

I connect a business always my analysis of the true cash flow with Val­u­a­tion of stocks. It is possible for a company, ter­ri­bly unprof­itable, but a good share if reflects the future cash flow Expec­ta­tion are low enough in his Val­u­a­tion.

Jus­tify at its current price ~$ 57, Star­wood would have to their after-tax cash flow (NOPAT) by more than 20% compounded annu­ally for 11 years grow. These are some high Expectations…not, high growth, but also the long Dura­tion of expected growth.

The highest sales growth by Star­wood in the last 10 years is reached 17% in 2002. Only in the last 10 years, two-digit Rev­enue gen­er­ated company has con­sec­u­tive years growth (16% and 11% between 2005 and 2006, respectively).

A share price Val­u­a­tion, which implies 11 con­sec­u­tive years 20% growth in NOPAT is for the most Com­pa­nies, espe­cially a hotel in a Global Econ­omy, expected to be too high for the fore­see­able future are rather weak.

With no future profit growth, the value of the star page is camp closer to $2 per share. While I don't nec­es­sar­ily expect that Star­wood will get any future earnings growth, I believe that no growth important perspective on how much growth in the share price is set at pro­vides and how much risk investors to take, by it hold­ing.

The below Fig­ure sug­gests that investors in the HOT stock in could be for some Trou­ble, if the story, which is repeated. The last time Starwood reported Earn­ings his Earn­ings defeat by more than 15%, the share over­stated $1960s fell over 70% of the Center up to the under $20 per share.

I also expect that Starwood Earn­ings over statement is again on more Nor­malem Lev­els da Com­pa­nies rules only so much can bow before them break­ing. In about the Starwood Understate­ment will no longer lever, if FASB is expected, change the applicable accounting rules and force companies operating lease liabilities on balance sheet report. This change is expected in the next year or so occur, and it will close the off-balance sheet liabilities of Loop­hole.

Star­Wood is a July stocks the most dangerous and calls my "very dangerous" risk/return Rat­ing. There are many Down­side risk mis­lead­ing Earn­ings given, while it embed­ded reward is less on the head in view of the already-rich Expec­ta­tions in the share price. More information on my Rat­ing and a free report on HOT are here.

HOT fits in a deal in which investors make money by buy­ing shares with low Expec­ta­tions rel­a­tive to their future Poten­tial, the Pro­file large stock short or sell.

Range: Huge profits drink with Jim Oberweis.  He is the guy who had subscribers in Baidu at $8 and rode, the Hansen natural (manufacturer of Monster drinks) for a 1200% gain. Click here for four stocks to buy and sell Now…in Oberweis report.

I rec­om­mend also the following ETFs "dangerous" Rat­ing and exposure, HOT sell­ing. Note is one of the Per­centile map where each ETF is under the 375 + US equity ETFs we cover 100% of the highest rating in the cor­re­sponds.

PowerShares S & P 500 high beta Port­fo­lio (sphb): 8. PercentileiShares Morn­ingstar mid growth index Fund (JKH) - 33. PercentileVan­guard mid cap growth ETF (TSR) - quantile of 34.

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