The wild swings that were the hallmarks of last year's stock market did much more than provide talking points for the pundits. They also rattled a lot of investors who, until then, had been pretty confident about how much risk they could handle.
The spectre of last year's dismal RRSP season — when markets were near the end of a heart-stopping 50 per cent slide — threatens to overhang this year's. While most experts don't expect another tumble of that magnitude, the investing public would clearly rather not go through that again.
So how do people with significant equity holdings in their RRSPs insulate themselves from all this volatility? We asked a variety of money managers and retirement specialists to suggest some nerve tonic for the cautious investor. Several themes emerged.
"Bonds are boring," acknowledges David Martin, a portfolio manager at Stonegate Private Counsel in Halifax. "When you turn on [the financial channels], it's all about equities. There's not a lot of bond talk."
But he points out that bonds were the best performing asset class in 2008 — managing a positive return in a year when the Canadian stock market lost a third of its value. A portfolio with a fixed income component fared better than one with just equities.
"Everybody should have some bonds," Martin says. "No one should be 100 per cent equities."
Follow the money
From April 1, 2009, to Oct. 31, 2009, money invested by Canadians flowed:
- Money market funds: $15.7 billion
- Equity funds: $3.6 billion
- Bond funds: $8.7 billion
- Balanced funds: $3.5 billion
Source: Investor Economics
It appears that more and more investors are getting that message. Figures from Investor Economics, a firm that researches the financial services industry, show that since the stock markets bottomed in March 2009, billions of dollars have been flowing out of money market funds — where people had fled during the crash — and were going into bond funds and balanced funds, which contain both bonds and equities. Funds that were invested primarily in equities saw net redemptions.
How much of one's RRSP should be in bonds?
The experts say that depends on risk tolerance, personal financial circumstances, age and time to retirement.
"For most Canadians, a portfolio with 40 to 60 per cent equities and the rest in fixed income" is a good starting point, suggests Adrian Mastracci, president of KCM Wealth Management, a fee-based financial planning firm in Vancouver. Some of his more cautious clients have virtually all their savings in fixed income investments.
"You can only be that conservative for a short period of time," Mastracci says.
But he notes that many portfolios are still under water, even after the recent rally. So the question of how best to recover those losses in today's low-yield environment is centre stage.
For some, that means a cautious acceptance of more risk. The experts say even the most cautious investors would be well-advised not to shun equities completely.
"Over the long term, markets do rise," points out Andy Beer, manager of strategic investment planning at Investors Group in Winnipeg. A conservative investor might put 70 per cent in fixed income (a mix of government and corporate bonds), with the balance in equities.
"If people are looking to get into equities, the safest way is through diversification," he says. That means not confining stocks or equity fund choices to Canada.
The experts agree that bonds may not be the most exciting investments when bull markets are raging. But they do add stability and protection on the downside. As Stonegate's Martin puts it, "The good thing that comes out of market declines is that people are more cautious about their investments."
Be wary of some 'guaranteed' products
Most people know that money market funds, T-bills and Guaranteed Investment Certificates are safe, but unexciting places to park money. For instance, a look at rates paid on five-year GICs shows that most banks are paying just 2 per cent annually.
Some investors may have noticed products that guarantee principal, while at the same time offering a chance to benefit from stock market gains. They're often called structured products. The offerings include Principal Protected Notes (PPNs) and equity-linked GICs. A typical PPN might guarantee a return of principal at maturity — perhaps five years from now — along with coupons that would pay up to 10 per cent annually, depending on the price performance of an underlying portfolio of Canadian stocks.
A typical equity-linked or market return GIC would similarly guarantee the principal at maturity — usually three or five years away — and would feature coupons that would return a share of the increase (if any) in a particular market benchmark or a portfolio of stocks or commodities.
Playing it safe
Amount of cash sitting in Canadian high interest savings accounts on Dec. 31, 2008 (before markets bottomed):
Amount invested there on June 30, 2009 (after markets bottomed):
Source: Investor Economics
Sounds like the best of both worlds — safety plus the potential to gain from market growth. But the experts say that guarantee comes at a price. For one thing, the firms that market these products — often the big banks — have to buy downside protection in case the markets really tank and don't recover. That cost is passed on to the investor. Also, the market gains are often capped at a certain percentage per year or they return only a certain percentage of a benchmark's growth (that's the "link" part).
They often have high fees, too.
"They're very good for the adviser. Not that great for the investor," says Adrian Mastracci of KCM Wealth Management.
Popular financial author Gordon Pape doesn't think much of them either. Pape called PPNs "an opportunistic marketing gimmick designed to play on your anxieties," in a warning he made to readers of 50plus.com.
There's also the question of whether long-term investors really need such guarantees. A look at 262 Canadian equity mutual funds with five-year track records showed that, as of Nov. 30, 2009, all but one of the funds had a positive five-year return, according to Globefund.com. Similarly, all but six of 173 Canadian equity balanced funds (which hold a mix of equity and fixed income investments) had positive returns over five years.
"With a long-term time horizon, I don't think you do need guarantees," acknowledges Doug Coulter, president of RBC Asset Management in Toronto. "I think you're paying for something you don't need mathematically," he says.
From an emotional standpoint, however, he says some investors do want that guarantee. While RBC offers protected notes, Coulter says the majority of RBC's fund sales these days are going into a variety of risk-adjusted portfolio solutions. "Clients are saying, 'Let's get back to basics,'" he says, but they're also willing to assume some degree of risk.
The life insurance industry offers its own kind of guaranteed products — segregated funds. These are investment products that are similar to mutual funds, but offer guarantees of 75 or 100 per cent of investors' principal at maturity. But they do tend to cost more than mutual funds.
"Some investors see such a guarantee as unnecessary since it is highly unlikely that market values will be lower than the principal investment over any 10-year period," according to Advocis, an association that represents thousands of Canadian financial advisers.
Use dollar-cost averaging
Many financial firms noticed that the uncertainty of the past year led some of their clients to move to the sidelines. If they did invest, it was cautiously. Some moved a substantial portion of their investments into cash to ride out the turmoil. Then, they watched as markets zoomed back up without them. For those wondering how or when to get back in, our experts suggest dollar-cost averaging — investing a set amount of that pile o' cash each month for three, four, six, or 12 months.
"It's a great way to get back into the market," says Andy Beer of Investors Group. "Park your lump sum in a money market fund and each month allocate a certain percentage into a diversified portfolio."
Beer notes that many firms — his included — have cut fees on money market funds in the current environment to boost returns.
Dollar-cost averaging is also a good strategy for making regular RRSP contributions.
"When you're looking at RRSPs or any investment contribution, it really benefits from dollar-cost averaging," says Lee Anne Davies, head of retirement strategies at RBC Royal Bank. "The other thing it does is create that savings habit."
For many people, it's a lot easier to come up with $250 a month than $3,000 once a year.