At the risk of being trite, the return to investors in their portfolios is a complex dynamic…essentially of everything going on in the world at points in time!

In order to gain a deeper understanding of the components of rate of return, for the last decade we have been tracking these components in a real portfolio on a quarterly basis.

We tracked six different components, each with varying proportions of import to portfolio success: cash income (being interest and dividends received), price appreciation, foreign exchange impact and other (essentially the tax value of dividend tax credits on Canadian stocks).  Price and foreign exchange each have two sub-components: realized and unrealized. “Realized” means that transactions have been executed to lock in the currency or price gains. “Unrealized” means that the currency or price gains are “on paperonly as you still hold the investment, and thus the gain at any moment in time can change with future market developments.

Any time analysis of markets can only offer “qualified” observations. Market cycles are long, and any intra-period data analysis only speaks to the period in question (in this case, ten years) and is not necessarily inferential, but at least interesting. We analyzed the accumulating quarters over that decade as well.

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The Cash income component is quite stable across time. A ballpark number today would be 2%, and indeed this portfolio consistently returned in a range from 2.21%-2.75% per annum across the ten years. The amount has dropped consistently over the decade because bond coupon rates have been falling.

Dividend tax credits are very consistent over time, and are a very small component.

The two wild cards are foreign exchange and price movement. Across the 40 quarters of the decade, foreign exchange contributed a quarterly high of 4.46% and a low of –4.9% but averaged out at only .16 of 1%. Our Spring Foresight edition annually reports on foreign exchange impact.

Price movement similarly contributed a quarterly high of 6.22% and a low of –7.51%. and averaged out at .52 of 1% per quarter. Notably, those two outliers were only 9 months apart!

The proportions between realized and unrealized returns may be influenced somewhat by the kind of  account(s) involved. In Trading accounts (which are non-sheltered), realizations can cause tax liabilities. In RRSPs, RRIFs and TFSAs (all tax sheltered accounts), tax considerations are not required in the “sell” decision. The real account in this article is a Trading account; therefore, taxes are an issue, and the realized components in the table above are minimized.

Information in your Annual Report provides perspective on the issue of component contribution. Below is the actual graph for our test portfolio, in which one can gain perspective on the relative contributions of price/exchange movement and cash income over this ten year time period:

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Clients who are retired, and perhaps in decumulation mode and thus seeking cash flow from the portfolio to fund life,  need to grasp insight from this information. The average cash income component was 2.7% pa while the average total portfolio return 5.6% pa. The table shows that roughly half of the return comes from Cash income and the remainder is largely from unrealized sources. Mandatory RRIF withdrawal rates are, for example, in the range of 4-8% through the early years of retirement, post age 71. Thus, the extra cash flow needed beyond Cash income (2.7%) to top up required withdrawal rates (4-8%) must come from capital in the short run, or conversion of unrealized price movement to realized price movement in the short to long run.

Lastly, the following graph is interesting as well, as it shows quarterly price movements (%)across the decade:

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On average, the quarterly price movement was 2.26% (absolute value) and there were 11 quarters with negative price movement, and 21 direction changes in the 40 quarters!