For long term investors, earning 5% to 7% annual return (after tax) is a suitable target to aim for. But this is difficult to pull off today. The current expected returns of the financial markets are extremely low by historical standards. Traditional asset classes such as stocks and bonds are generally overvalued now.
Stock Market Expected Return = 3.2%
The Shiller P/E ratio is currently about 31 for the S&P 500 stock market index. This is much higher than the historical average ratio of 16. The Shiller P/E ratio is based on average inflation-adjusted earnings from the previous 10 years. The inverse of the ratio (1/31) is how much the market is expected to earn for investors going forward.
Bond Market Expected Return = 2.3%
Here are some popular bond ETFs.
- BMO Aggregate Bond Index ETF (ZAG) – Weighted Average Yield to Maturity = 2.34%
- Canadian Aggregate Bond Index ETF (VAB) – Weighted Average Yield to Maturity = 2.28%
- iShares Core Canadian Universe Bond Index ETF (XBB) – Weighted Average Yield to Maturity = 2.35%
As we can see, all their Avg YTMs are below 3%. The 10 year Canadian government bond is paying only 1.9% as of writing this post. 🙁
As a long term investor I don’t see the point of buying a bond that pays less than 2% interest when the Bank of Canada openly declared it wants to erode the Canadian dollar’s value by 2% a year. That effectively creates a projected negative real return on investment, 😮 ouch. This is why I stay away from ETFs like these which primarily hold low yielding government bonds. These funds aren’t necessarily bad investments. I’m just saying they’re not for me. We can find slightly higher yields in U.S. bonds, but not much better.
Where Can We Still Find 5% to 7% Return Today?
There are still good opportunities out there. But we need to think outside the box and look at alternative ways to use our money. I don’t have all the answers but here are some ideas that are worth thinking about. 🙂
- High yielding dividend growth stocks – I recently wrote about why ENB is a good buy right now for long term investors looking for income. Enbridge Income Fund (ENF) and Inter Pipeline Ltd (IPL) are also utility companies paying over 6% dividend yield with little risk of cutting their dividends in the foreseeable future. The idea is to get paid 6% in eligible dividends while waiting for the broader stock market to cool down. 🙂
- Peer to peer lending – I started to invest in Lending Loop about a year ago. So far my annual return, net of fees, is 12%. 😀 After accounting for potential loan losses and taxation I expect to ultimately earn 7% a year from this investment.
- Cryptocurrencies. – Earlier this year I wrote about buying some Ethereum. Since then I have also bought some Bitcoin and Litecoin. There is a lot of upside potential in this new asset class, but it’s very speculative. I wouldn’t recommend putting more than 5% of one’s net worth in digital currencies.
- Consumer Goods. – Sometimes we need to invest in ourselves. We can treat ourselves to a well deserved vacation, a new TV, a wardrobe upgrade, winter tires, or an Instant Pot. Since the expected value of monetary gain through investing is low right now, using money for other purposes (such as buying instant gratification) will have relatively more value. Happy Black Friday! 🙂 Go buy yourself something fun. 😉
These 4 ideas will most likely pay higher rewards than the low, single digit returns expected from traditional asset classes such as stock and bond index funds. Feel free to share your thoughts in the comments if you can think of other ideas. 😀
Random Useless Fact
The P/E ratios are so high today because the interest rates for borrowing are also historically low. You can’t really compare P/Es from today and the past without also accounting for the rate you would be paying to borrow the cash as well. No need to fret about that chart. 😉
That’s a great point. The financial markets are very interconnected to the economy. Low interest rates is also the main cause for housing affordability in much of the country.
Sell put options with less than 30 days to expiration and do this every month. An example, WJA.TO December 15 2017 $26 put option at $0.40. So for 21 days, that would be a return of 1.48% for 21 days or 25.75% annualized.
If option gets assigned then write covered calls.
You are better off just buying and holding.
JNJ currently at 131$.
Write cash-secured put for JNJ @130$. You bank a premium of 1$. Then the options is exercised at 125$.
Then you write a covered call for JNJ @130$. You bank a premium of 1$. Then the options is exercised at 135$.
JNJ currently at 135$.
Your return as an option speculator: 2$
Buy and hold investor’s return: 4$
So, yeah. Forget that option strategy. Here is an excellent article about this: https://seekingalpha.com/article/4105727-johnson-and-johnson-decrease-investment-returns
Great Black Friday post! I bought myself a new purse and boots today haha 🙂 I haven’t touched crypto currencies and don’t plan to- don’t know enough about it.
I don’t know much about it either. I just have a bad case of FOMO lol. 😀
Liquid, Agree with your premise that 5-7% annual after tax returns are tough to find these days with markets at all time highs. I don’t worry about it much since I try to invest incrementally over time. I think we need a good correction in the financial markets before we will see higher potential returns again. Unfortunately, I can’t think of any better ideas than what you highlighted. Keep some cash ready for when the next opportunity comes around. Tom
Keeping a lot of cash on hand is another good strategy that can work for many investors. You don’t have to wait for the next financial crisis to deploy the cash. With so many bubbles today in various asset classes you just need one of them to correct. 🙂
There are plenty of decent alternatives, they may take some digging. Stocks such as AT&T,CVS, and other great dividend stocks are trading at a discount. And you can also pay down some debt more aggressively if you are not liking any investment ideas. Sure you aren’t increasing cash flow, but you are decreasing cash outflows. Can’t hurt if all other options are very expensive.
Good idea. The lower the market expected returns, the more debt we should pay down due to opportunity cost. Thanks for the stock suggestions too.
I think these days its important to pay off the line of credit …that would be around 6 to 7% for an unsecured line. Wait for the correction and go all in…with options and leverage.
Yes, my line of credits cost the most to maintain. I’m trying to pay them down by at least $1K a month.
I’m still looking at the beaten down U.S. companies that yield historically high figures. GIS, HRL and CAH come to mind. GE could be an interesting play after the divvy cut. There’s always a place to invest. The key is finding the potential best returns which will only be realized in hindsight.
I was looking GE too. It’s down 42% so far this year and Jim Cramer thinks GE stock could bottom out at $17/share. I think it is interesting but I don’t know enough about the board or executives to decide if I should invest in them. Maybe in the long run GE will outperform, but if it takes them another year or two to turn things around then maybe it’s better to wait.
How will the gains in peer-to-peer lending and cryptocurrency be treated in filing the income tax return?
Gains from P2P lending will be treated as interest income and taxed at my marginal tax rate. The company LendingLoop will send out tax documents for all its investors.
Gains to cryptocurrency are subject to capital gains tax similarly to buying and selling precious metal bullion. But these are just my understanding and may not be accurately aligned with CRA rules. Cryptocurrency is still a grey area and governments around the world are still trying to figure out regulation around it. Earlier this year Russia, China, and South Korea have banned initial coin offerings and cracked down on bitcoin exchanges. Some Canadian banks have been known to close people’s chequing accounts if it sees transfers going to and from a bitcoin exchange. According to some regulators, if you trade bitcoins you’re probably doing something nefarious lol.
Cryptocurrencies…There is a lot of upside potential in this new asset class
It is not a new asset class. But whateves.
Almost all the upside is coming from trading volume; almost none of the upside is from it being used as currency. Hope you’re taking profits.
I might take some bitcoin profits soon. 🙂
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