Aging baby boomers may want to play defence in their investment portfolios amid renewed market volatility, but it's not so easy.
Facing a potentially longer lifespan than their parents, many investors in their 50s and early 60s need to be more open minded and take on more risk to avoid outliving their nest eggs, financial advisors say.
The problem with shifting money into conservative investments such as guaranteed investment certificates (GICs) and government bonds is that inflation eats away at puny returns. And interest rates, which are poised to rise, can hurt bond investments as the market price for their securities declines when rates climb.
"Income is the reverse beauty contest," says John DeGoey, a portfolio manager with Industrial Alliance Securities in Toronto and author of The Professional Financial Advisor IV. "You are trying to find a product that is the least ugly."
Despite the complexity of principal protected notes (PPNs), a product sold by banks, Mr. DeGoey likes some of them as a source of income. He prefers notes linked to a market index or basket of stocks that can provide more potential upside. But they also give principal protection if held to maturity, which can be five or six years, he said. "If the stock market drops, you at least get your money back."
Under the old rule of thumb for asset allocation, investors subtracted their age from 100 to find the percentage to keep in equities. A 50-year-old investor would hold 50 per cent in stocks and 50 per cent in fixed-income investments.
But that strategy is "ridiculously conservative" because today's pre-retirees need a higher equity weighting, he argued. "This generation will live longer than any generation in history, so they need their money to last longer."
Instead, investors might calculate their fixed-income portion by multiplying their age by the decimal of their age, he said. For example, a 50-year-old investor (multiply 50 x 0.50) would hold 25 per cent in fixed-income and 75 per cent in equities. Investors should not get to a 50-50 portfolio until age 71, when they convert their registered retirement saving plan (RRSP) to a registered retirement income fund (RRIF), he suggested.
Investing in broad-based equity exchange-traded funds (ETFs) rather than individual stocks can also be a more defensive strategy, while choosing low-fee funds is "common sense" because investors keep more of their returns, he added.
Among equity funds, he likes Canadian-listed Vanguard FTSE Canada ETF; Vanguard U.S. Total Market ETF; Vanguard FTSE Developed AllCap ex U.S. ETF and Vanguard FTSE Emerging Markets All Cap ETF.
Lorne Zeiler, a portfolio manager with Toronto-based TriDelta Financial, agrees that today's pre-retirees seeking income should have exposure to "some high-risk assets just because of the low returns they are getting on bonds."
His firm's asset allocation approach begins with a targeted return and considers many factors, including the level of volatility that a client can withstand in a portfolio. An investor in his or her 50s or early 60s might have 55 per cent in equity, 30 per cent in fixed income and 15 per cent in alternative investments, he said.
The last group includes income-paying equity investments, such as preferred shares and real estate investment trusts. The main securities, however, would be private credit and mortgage corporation funds that can offer stable yields of 6 to 9 per cent a year, but require careful scrutiny because these investments vary in quality and risk, he cautioned. For sophisticated investors, he likes Sprott Bridging Income Fund LP and TREZ Capital Yield Trust U.S.
As part of an equity allocation, pre-retirees should focus on larger-cap, dividend-paying stocks, but also be mindful that valuations have gotten higher, he said. In Canada, he likes BCE Inc. and Telus Corp. among telecom stocks, and TransCanada Pipelines Ltd., Enbridge Inc. and Fortis Inc. among utilities.
Investors should also have exposure to the U.S. market for currency diversification and access to a broader range of dividend stocks in areas such as technology, health care and consumer goods, he added.
"We like health care [now] for its reasonable valuations, stable earnings growth and dividend yield," he said. "It [the sector] largely did not participate in last year's equity rally due to overblown fears of regulation." AbbVie Inc., Johnson & Johnson, Abbott Laboratories Ltd. and C.R. Bard Inc. are names he likes in this sector.
A diversification strategy should also include investing in emerging markets, Europe and Japan because they are offering more attractive valuations and relatively higher dividend yields as worldwide growth picks up, Mr. Zeiler said. Among the funds he likes are the U.S.-listed iShares Edge MSCI Minimum Volatility Emerging Markets ETF and iShares Edge MSCI Minimum Volatility EAFE ETF.
Edmonton-based fee-only financial planner Jim Yih said he doesn't dispute the need by pre-retirees to own more conservative and safer investments, but making it happen can be challenging.
"For instance, I own investments like iShares Canadian Select Dividend ETF, BMO Equal Weight REIT ETF and Royal Bank stock," said Mr. Yih, who is 47 and also runs a person financial blog called retirehappy.ca.
"But are they conservative?" he asked. "Some will look at them as equities. Some will see them as conservative equities. And because they pay a regular income, some will look at them as fixed income."
But they are all riskier alternatives to low-paying, fixed-income investments, he said. "The problem with the words 'safe' and 'conservative' is that they have different meanings to different people."