It\u2019s no surprise that the global financial crisis has made investing more difficult for your risk-averse clients who are approaching retirement.
That\u2019s because interest rates are so low that clients won\u2019t get much income from the guaranteed income certificates, bonds and annuities they typically would buy now. And, to add insult to injury, consumers continue to see inflation eat away at their purchasing power.
Furthermore, bonds purchased today will lose value once interest rates start their inevitable climb back to normal levels. That will result in losses if clients have to sell their bonds before maturity.
Thus, many financial advi-sors are suggesting their clients use any spare cash they may have to buy dividend-paying stocks, which both offer the possibility of higher dividends and\/or stock price appreciation and benefit from the dividend tax credit if the issuing companies are Canadian.
Says Avery Shenfield, chief economist with CIBC World Markets Inc. <\/b> in Toronto: \u201cThe yields on stocks that pay good dividends and whose earnings are growing are currently more attractive than [those of] bonds.\u201d
And Barb Garbens, president of Toronto-based financial planning firm B L Garbens Associates Inc., <\/b> notes that Canadians can earn up to $40,000 in dividends without paying any taxes.
The low interest rate also means that the annuities currently being offered have low returns, so if your clients can put off buying an annuity until rates have increased, they would be wise to do so. (It should be noted that there is no reason to sell the bonds your clients already own; indeed, if they were bought more than three years ago, they probably are generating a decent income.)
Interest rates will increase once it\u2019s clear that economies are on a sustainable, healthy growth path. At that point, bonds will be as good and as safe as they usually have been \u2014 and your clients can return to their target amounts of fixed-income. Such a time would also be good to buy annuities, should they be part of clients\u2019 financial plans.
Most economists think economic growth in the U.S. and Canada will pick up gradually, with interest rates also moving upward at the same pace. This delay in the return to normal conditions means that although you should draw up financial plans based on a normal interest rate environment, you also have to figure out how to make the transition to the target asset mix.
You could, for example, hold off on reducing equities, if that\u2019s part of the plan, until interest rates have returned to normal \u2014 and even increase dividend-paying equities with any spare cash your clients may have. There is no harm in holding dividend-paying stocks for an extended period if they are providing more income than fixed-income products.
One thing that needs to be taken into account in new or revised plans for those in or approaching retirement is future inflation. Inflation is currently very low and is not expected to be a problem in the short term. However, there is a possibility that governments \u2014 which now have huge debt loads resulting from the massive stimulus packages they put in place in the wake of the financial crisis \u2014 will encourage inflation to make it easier to reduce their debt.
This is because of the way monetizing debt works: the higher inflation is, the less the proportion of a government\u2019s revenue will be needed to pay off its debt. If inflation is 2% a year, most wages will rise by a least that much \u2014 and so will income-tax revenue. In 10 years with 2% inflation, revenue that is $100 billion today will be at least $119 billion. Meanwhile, if inflation is 5% a year, revenue will be $163 billion or more. However, a debt of $50 billion will still be only $50 billion in 10 years, so it will be much easier to pay it off if inflation has averaged 5% vs 2%.@page_break@Even if governments don\u2019t encourage inflation, your clients need to understand what inflation of even 1% or 2% can do to their purchasing power. For example, $30,000 in GIC, bond or annuity income would be equivalent to $27,100 in today\u2019s dollars in 10 years if inflation is 1%; $24,500 if inflation is 2%. In 30 years, that income would be equivalent to $22,200 with 1% inflation or $16,400 with 2% inflation.
It\u2019s also important to discuss inflation and how it may change in the future. For example, Sheila Munch and Glenda Baker, senior financial planning advisors with Assante Wealth Management (Canada) Ltd. <\/b> in Oshawa, Ont., typically use a historical 3% inflation rate in most of their projections; they will use a higher rate at the clients\u2019 request. They recommend using a higher rate \u2014 normally 5% \u2014 when dealing with educational costs because tuition fees have been increasing at a fast clip. Institutional-term care costs have also been rising more than general inflation.
Straight-line projections are useful for making points about things such as the ravages of inflation, but the financial crisis has shown their limitations. Investment returns are often very volatile, weak or negative in some years, way up in other periods, then in between in other years. Using software that incorporates such volatile behaviour can be helpful. Ga\u00e9tan Ruest, director of strategic investment planning with Investors Group Inc. <\/b> in Winnipeg, says his firm doesn\u2019t typically do projections but finds \u201cscenario-testing\u201d of financial plans useful.
One way of moderating the ups and downs in investment returns is by including non-correlated assets in portfolios. The past few years have shown how closely financial markets around the world tend to move in tandem. This reduces the benefit of geographical diversification, although it doesn\u2019t eliminate it. The S&P\/TSX composite index is very heavily weighted in resources and financial services companies and has little or no representation in other important economic sectors. There are, for example, no car manufacturers or drug companies on the index.
It\u2019s worth considering non-correlated assets \u2014 those whose returns do not move in tandem with global stock and financial markets \u2014 to provide steadier returns and less volatility. Garbens, for example, recommends investing in gold, other resources commodities, real estate and dividend-paying stocks for this kind of diversification. \u201cThere may not be great highs,\u201d she explains, \u201cbut there shouldn\u2019t be big lows.\u201d
Besides a mix of non-correlated assets, Garbens also recommends a mix of products, with some aimed at producing an income stream, some with growth potential to protect against the erosion of purchasing power from inflation and some guaranteed investments linked to equities to ensure clients get some of the upside if stock markets do well.
One question that hasn\u2019t changed is how much exposure Canadians should have to foreign currencies. Many experts recommend geographical diversification even though exchange rate movements can play havoc with financial plans. The rise in the value of the Canadian dollar vs its U.S. counterpart to US$1.03 in late 2007 from US62.5\u00a2 in January 2002 had a negative impact on the returns on U.S. investments when turned into C$. When the C$ goes up, your clients get less for the equivalent in US$. For example, an investment of US$10,000 when the C$ was at US62.5\u00a2 was worth C$16,250, but worth only C$10,000 when the currencies are at par.
Many economists think the C$ will remain in the US90\u00a2-US$1 range, but they could be wrong. Exchange rates are one of the most difficult things to predict because so many factors determine how they will move. Some advisors prefer that their clients who don\u2019t travel much outside Canada have most of their investments in Canadian securities; others believe geographical diversification is essential in minimizing risk, and that either exchange rate movements will even out over time or suggest investing in global mutual funds that either employ 100% currency hedging or in which the fund managers hedge currency risk when they feel it\u2019s appropriate.\t
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The economic recovery is not yet on solid footing, so getting income from traditional products such as bonds, GICs and annuities is an exercise in futility. Here are some ideas for getting income and returns for your risk-averse clients<\/p>\n","protected":false},"author":4,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[3013,3018],"tags":[2403],"yst_prominent_words":[],"acf":[],"_links":{"self":[{"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/posts\/317645"}],"collection":[{"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/users\/4"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/comments?post=317645"}],"version-history":[{"count":1,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/posts\/317645\/revisions"}],"predecessor-version":[{"id":363326,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/posts\/317645\/revisions\/363326"}],"wp:attachment":[{"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/media?parent=317645"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/categories?post=317645"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/tags?post=317645"},{"taxonomy":"yst_prominent_words","embeddable":true,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/yst_prominent_words?post=317645"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}