By Olev Edur
Given that efforts to curb inflation have pushed interest rates higher, you might be tempted to fiddle with your investments to profit from those higher rates—but should you?
Inflation has been a major problem for many retirees over the past 18 months, but it’s gradually coming down as central banks everywhere raise interest rates to help stifle the demand that has led to those price increases. While higher interest rates are bad news for borrowers, there’s a silver lining for savers: higher interest rates can mean higher income, and many types of interest-generating investments are government-guaranteed.
Should you be thinking about making changes to your investment portfolio to take advantage of those higher rates while they’re still around? After all, once inflation drops to the Bank of Canada’s target of around two per cent, interest rates will soon follow. And what about equities? With many analysts predicting an economic slowdown or even a recession in the near future, should you consider moving into more defensive types of holdings?
According to Steve Bridge, a North Vancouver-based advice-only financial planner with Money Coaches Canada, such changes may or may not be advisable; your decision has to be considered within the context of your overall retirement financial plan. “All these answers start with ‘It depends,’” he says. “It depends on your age and the life stage you’re at, your investment timeline, and your tolerance for risk.
“You need to start by creating an investment policy statement. This statement covers five points: your overall investment strategy, target allocations, risk tolerance, investment guidelines, and rebalancing. It doesn’t have to be a long document—it can be just a single page. Using the policy statement as a guide, you can build a balanced and diversified portfolio that’s appropriate for your circumstances.”
The Importance of Liquidity
Bridge suggests that you should always have enough liquid assets to tide you over any market downturn. “More specifically, we advocate keeping the equivalent of two to three years’ worth of spending in cash or near cash, perhaps in high-interest savings accounts or other liquid investments,” he says. “This will allow you to weather any storm in the stock or bond markets. The markets always bounce back within 18 months or so after a downturn, but you need to prepare so that you don’t have to cash out when the markets are down—cashing out when the markets are down can have negative consequences for the rest of your life.”
As for the attraction of current high interest rates, Bridge acknowledges that this may be a boon for some investors, but, again, it depends on what your policy statement dictates. “Many people feel that GICs, for example, represent a way for them to earn income while preserving their capital,” he says. “If this is important, then yes, a form of GIC ladder over one to five years can ensure that you won’t lose any money.” (For those unfamiliar with the concept, a GIC ladder involves purchasing GICs with staggered maturity dates ranging from one to five years so that cash becomes available every year, should it be needed; if it isn’t, it can be reinvested to continue the ladder.)
On the other hand, some may not feel the need for fixed-income investments at all, despite the higher interest rates. “I have one client, for example, who is 90 years old, yet 100 per cent of his money is in equities,” Bridge says. “That’s not the typical arrangement, but it’s suitable for him and he’s comfortable with it.”
There are, of course, many fixed-income alternatives to GICs, such as bonds, mutual funds, and exchange-traded funds (ETFs), and, as exemplified in the box on page TK, some entirely new types of products geared specifically to retirees are now becoming available.
“ETFs are available in various forms, and they’re a low-fee option that provides broad diversity, both geographically and in terms of duration,” Bridge says. “And annuities are becoming more attractive in this higher interest rate environment. If you’re a person with no pension and very little in guaranteed income, putting one-quarter to one-third of your liquid investments into an annuity will give you guaranteed income for life. But if you’re shopping for an annuity, you should always get at least two quotes.”
The Stock Markets
As for moving to more defensive stocks now that a recession may be on the horizon, Bridge says that when it comes to equity allocations, the best strategy is to build a suitable basket of holdings and then just stick to it. “Frequent rebalancing ends up costing you money,” he points out. “It’s sometimes said that an investment is like a bar of soap: the more you touch it the smaller it gets. I recently listened to a speech by the CEO of a large investment firm, and he said he checks his investments only once a year. And some of my best-performing clients say they simply forget about having an investment account.”
One problem is that, when it comes to the stock markets, “we are often our own worst enemy,” Bridge says. “The way to profit in the markets is to buy low and sell high, but when the markets go up, your dopamine kicks in because you want more of those high returns. And when the markets go down, you get fearful of more losses and start to sell. You end up buying high and selling low.”
In addition, Bridge says, “people often look at past performance and think that if an investment did well last year, it should do the same this year. But if you look at track records, what was good last year will probably not do well this year; it’s never the same year after year. So, I generally recommend that people maintain a diversified portfolio, perhaps using low-cost index funds, and avoid reacting to news or chasing returns.”
While Bridge is an advice-only financial planner and so doesn’t manage investments or make specific recommendations, he does suggest that the cost of employing a skilled investment adviser to manage your holdings can more than pay for itself, provided the fees are within limits.
“Fees matter,” he says. “I draw the line at one per cent or less, but sometimes the effective rate can reach two or three per cent.” That can make quite a difference: an annual fee of, say, 2.5 per cent compounded over 20 years can amount to almost two-thirds of your original investment, possibly even more if your portfolio grows over time.
If your portfolio is relatively straightforward, Bridge suggests that a so-called “robo-adviser” can be an attractive low-cost alternative—you plug in the relevant parameters and then let the automated system handle all the necessary decisions. “A robo-adviser charges low fees, takes emotion out of the equation, and will rebalance automatically,” he says. “You do, however, need to be comfortable with computers because this is something you would have to do online.”
Finally, Bridge has a word of advice for couples: “You should always involve your spouse or partner in what you’re doing, so that they know what and where everything is. With too many couples, one person does all the investing, and if he or she becomes incapacitated or passes on, the other person doesn’t know what to do. It becomes highly stressful at a time when he or she is also grieving.”
Lifetime Income Fund
A relatively new retirement product is the Longevity Pension Fund, which bridges the gap between regular mutual funds and pension plans or annuities. Introduced by the investment management firm Purpose Investments Inc., the fund promises income for life, but it has more flexibility than pension plans or annuities offer. You can, for example, change your mind and withdraw all or part of your remaining investment from the plan at any time, without penalty.
The trade-off for this flexibility is that the payments aren’t fixed; they depend on actual investment experience from year to year. However, the fund’s yields are based on very conservative assumptions that have been vetted by an independent actuarial firm, and in the fund’s first year, the payout to investors was actually higher than originally promised, despite poor market performance.
The fund’s holdings are based on a balanced portfolio of equities, fixed income, and cash holdings, and fund management fees are a relatively modest 0.6 per cent. Simon Barcelon, Purpose’s vice-president of product, notes that the concept has garnered interest worldwide.
Barcelon says that while the yield initially projected was 6.15 per cent, the current yield is 6.78 per cent. If you were age 65 and invested $50,000, for example, you could expect to receive roughly $3,390 for the year, payable in monthly instalments.
And the payments are projected to increase over time because, as with pension plans, the payouts take into account actuarial assumptions about people passing on or opting out of the plan—those remaining in the plan share the future gains forfeited by these people.
In all, this may prove to be a very useful product for retirees seeking greater lifetime income security, and we’ll review it in more detail in a future issue. For now, you can find out more by contacting Purpose directly at 1-888-557-5020 or purposeinvest.com. Just be sure to run the details past a qualified investment analyst before signing on.