Returns being overestimated: Sheather

Advisers are chronically overestimating future portfolio returns to the potential detriment of their clients, one commentator says.

Thursday, December 4th 2014, 6:00AM 2 Comments

by Susan Edmunds

Brent Sheather, of Private Asset Management, said too many New Zealand financial advisers were relying on historic returns when discussing how portfolios might be expected to fare in future.

That could have a negative effect on clients as they tried to work out how much they would need to save for their retirements, he said.

“If you overestimate returns, they won’t save enough and they will have the wrong idea about how much they can draw down.”

It was misleading to suggest that returns would be as high in future as they were in the past, he said.

He said it was important to differentiate between forecasting for the next five or 10 years and long-term forecasting.

Sheather pointed to the Gordon Growth model of predicting long-term returns. “This model simply says that the future return on shares is equivalent to the dividend yield that you buy the shares at plus the growth in dividends that will occur in the future. Numerous studies have shown that growth in the long run is pretty constant at inflation plus one or GDP growth minus one.”

Current, more expensive share prices would result in lower prospective returns. “This is basic stuff but it’s not what gets taught. It’s a huge indictment on the Code Committee,” Sheather said.

But the financial advice industry had a vested interest in overestimating future returns, he said, because it enabled higher fees to be charged.

He said that was why some regulatory action should be taken.

“If you feed rubbish assumptions in, you’ll come up with rubbish recommendations for clients, that’s for sure. Having some perspective as to what is realistic has to be absolutely fundamental.”

Other countries had legislated the assumptions advisers should use, Sheather said, and New Zealand could consider following suit.

“What are the implications for getting it wrong? Not saving enough, drawing down too much, clients getting pissed off. That’s why England has legislated, maybe the FMA should do the same thing.”

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Comments from our readers

On 4 December 2014 at 10:24 am traveller said:
absolutely right Brent, probably double the actual return. The trouble is, if advisers told the true story, they would never get any business!
On 8 December 2014 at 9:05 am Peter Urbani said:
Personally I favour education over legislation. Unfortunately you can take a horse to water but you cant make him drink. Ideally it needs to be done at school level where the importance of saving 5 - 10% of your paycheque from day one is impressed upon people. Only by starting early can the pressure to perform and chase returns later in life, when most people actually start saving, be avoided.

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