Defensive investing back in vogue

Investing in the current turbulent markets is like defensive hockey; play for the tie.

In hockey terms, playing defensively often means pushing opponents from in front of your net, clearing the puck and absorbing some body checks as you wait for a premium time to go on the attack.

It might be a bit of a boring style for the armchair athlete, but it's one way you can get a victory — or at least prevent a loss.

Investing in these turbulent markets is like playing defensive hockey — a lot of grinding is needed to get a tie. 

"In this market, you have to take a deep breath … and don't forget to exhale," said Andrew Rice, senior adviser with Toronto's Stewart & Kett Financial Advisors Inc.

Panic on Main Street

Some investors who enjoyed the upward ride of equity markets for the past few years might be tempted just to hold their breath until they faint.

After all, Toronto's TSX has not just fallen but has positively crashed in recent months — down 45 per cent from its 52-week high.

Commodity prices, once a reason to invest in the Canadian market, have slid precipitously for all kinds of materials.

Oil now hovers around $55 US a barrel. Copper is at a three-year low of $3,375 US per tonne. Aluminum prices could drop to 90 cents US a pound in 2009, down from an average price of $1.20 this year, according to the Bank of Montreal.

All this turmoil has left investors beating on the doors of their financial planners with one partly angry, partly plaintive question: "What do I do?"

"It's emotional right now, and it's not like this market is going to calm people down," said Christopher Snyder, chairman of the ECC Group, a personal financial advice company based in Toronto.

Start slowly

But if you want to limit your losses and start turning your finances around, you have to get back to basics, experts advise.

"It's not sexy," Rice said.

The first notion is to revisit your strategy — if you had one — and see if the trade-off between a higher risk and lower return still fits your thinking, experts said.

If what you were following before the market meltdown still works, then go back to it, said Pat Naccarato, vice-president at Canadian mutual fund company AIC Ltd.

Indeed, you can use slumping equity valuations to load up on high-quality issues and get your equity-to-debt ratio back to its former state, he said.

Kill the weak

Equally, however, investors need to decide if their high-risk holdings, which were supposed to yield big returns, are ever going to regain their former glory, market watchers said.

Stocks that relied too much on borrowing and rising market valuations to fund their businesses probably will keep getting punished in the current meltdown, Naccarato said.

If these issues have no hope of recovering in the near term, sell, take the loss and invest in something that will improve your portfolio, not act as a weight keeping your financial nest egg pea-sized.

Low interest rates mean low returns

Naccarato, however, does not like the notion of slamming all your assets into cash without any plan for eventually investing the money, or loading up on government bonds or other almost-riskless investments, such as GICs, forever.

The cash strategy is pure panic and only works for people who need to make a large purchase, such as a house, within the next year or so.

Sheltering your money in bonds, while more sensible, has other pitfalls, Naccarato said.

First of all, with interest rates approaching zero, the returns on government bonds and similar financial instruments are correspondingly low.

For example, the average yield for one- to three-year term government of Canada bonds was around two per cent in November, about half of the return on the same bond last year, mimicking interest rate cuts during the same period.

Worse still, the underlying prices for government or corporate bond issues increase when interest rates fall. With borrowing costs already pretty low in Canada and the United States, interest rates could begin to rise as the economy recovers, sticking bond investors with big capital losses in the process.

Boring dividends suddenly interesting

One eventuality with the current stock market, however, is that what goes down will eventually go back up, experts agreed.  Essentially, stocks will begin to rise.

"They will come back," said ECC 's Snyder.

The trick is to get some return into your portfolio while waiting for the upswing.

Dividend stocks, often attached to larger capitalized issues such as banks and utilities, might offer investors a decent return with a chance to gain when the economy turns around.

And, with depressed stock prices, they have become even more attractive.

Right now, for example, the average dividend yield — the amount the company gives out as a special payment divided by its current stock price — for the U.S. stock market as a whole is higher than the yield for the U.S. government's 10-year bond, Naccarato said.

Dividend yields  (%)
RBC 5.06 
Source: Morningstar Canada

That is the first time that situation has surfaced since the 1950s, he said.

Thus, a person can make more money by banking that dividend than he or she could by sinking money into government bonds.

Better yet, once the stock market begins to rise, investors who already own the underlying equity enjoy the ensuing capital gains from their holdings.

Of course, companies can cut such hugely expensive outlays at a moment's notice, such as when Citigroup recently reduced its dividend to almost nothing.