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Here’s Something More Important Than Portfolio Returns

Close-up of a Canadian bank note

By far, no investments have delivered greater returns than stocks over the long haul. So, you should consider focusing your portfolio on stocks over bonds or other fixed-income investments if you have the appetite to take on the risk of owning the underlying businesses of stocks.

The average long-term returns of the U.S. market is about 10%, while the Canadian market return is typically lower. Among stocks, small-cap exchange-traded funds (ETFs) with a focus on growth rather than value have tended to deliver even slightly higher returns.

Generally, when you buy individual stocks, you want to aim for returns of at least 10%. Otherwise there’s no point in stock picking and you might as well just buy the U.S. market via an ETF such as the SPDR S&P 500 ETF Trust.

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What’s more important than the rate of returns you’re getting is the amount of risk you’re taking. As an exaggerated example, investors can get many times their investment back by investing in penny stocks. On the other hand, investors can lose their shirts investing in such stocks.

When you pick individual stocks, you can choose the highest-quality of businesses to own to lower your risk but aim for a 10% rate of return.

It’s common for Canadian portfolios to hold at least one of the Big Five Canadian banks as a core holding. Relative to many stocks on the Canadian markets, the big banks are low-risk investments.

For instance, the leading banks, Royal Bank of Canada (TSX:RY)(NYSE:RY) and Toronto-Dominion Bank (TSX:TD)(NYSE:TD) tend to trade at discounted multiples but deliver consistent returns on equity in the teens as well as stable growth of 7-9%. Both stocks trade at multiples of about 12.5, which are reasonably valued.

As long as they continue to trade at this multiple and increase their earnings per share steadily as they have in the past, both stocks can deliver a rate of return of at least 10% from an investment today.

So, investors will get a +3% return from their dividends and the remaining returns from steady price appreciation.

Royal Bank and TD Bank have paid dividends for many years. Going forward, with a payout ratio of about 50%, the stocks have room to continue increasing their dividends for many years to come.

Shareholders can expect dividend hikes that roughly match the rate of growth for the banks’ earnings per share.

Investor takeaway

Before investing in anything, think about its downside risk before its returns potential. This way you’ll increase your success rate, your returns, and your wealth in the long run.

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Fool contributor Kay Ng has no position in any of the stocks mentioned.

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