The Bank of Canada's new governor, Stephen Poloz, said recently that the Canadian economy has yet to fully recover from the devastating effects of the 2008-09 recession. It turns out that the international downturn and gut-wrenching market crash that accompanied it have skewed the investment accounts of far too many Canadians just as they are hitting the home stretch for retirement.
So what does a recession-scarred portfolio look like? Too much fixed income, too little invested in equities and too much Canadian content. In other words, a dangerous lack of diversification.
It is a scenario that Steve Shepherd, vice-president of investment strategist and portfolio manager of BMO Global Asset Management, sees far too often. "People got away from their prescribed mix following 2008-09 because everything went out the window. The challenge that we have been finding is getting people back to their prescription, so to speak."
For people edging closer to retirement, the natural tendency is to reduce risk and volatility as much as possible within their portfolios. Traditionally that would mean loading up on government bonds, guaranteed investment certificates and other secure fixed-income securities. Over the three-decade long bull market for bonds that has accompanied steadily falling interest rates, it has also proven to be a very wise strategy.
Today, a portfolio stuffed with bonds could prove to be a ticking time bomb, Mr. Shepherd warns.
"A lot of people don't realize how far bonds have come," the Toronto-based investment strategist says. "The 30-year bull cycle for bonds is, if not at an end, coming to an end imminently."
That should prompt Canadians to go through a serious re-evaluation of their investments, preferably with a professional adviser, to determine whether their investment mix is suitable for a future of higher interest rates or is still a product of the Great Recession.
"The first thing to think about is fixed-income exposure," Mr. Shepherd advises. "People need to be looking at diversified sources of income, if they are using bonds to generate retirement income or yield. The idea that bonds can't lose money is something that people have to get over."
With interest rate risk increasing, investors looking for income or yield should broaden or diversify their holdings. Rather than stocking up on low-paying, super safe government-issued bonds, people should be buying dividend-paying stocks, investment grade corporate bonds from Canadian and international firms and, yes, even some non-investment grade and high-yield corporate bonds. Or what used to be called "junk bonds."
With the market crash of five years ago all too fresh in investors' memories, it is understandable that people would shy away from junk bonds, but for professionals such as Mr. Shepherd, rising interest rates are a greater threat to blow a hole in your portfolio than companies defaulting on loans. "Right now credit risk seems a lot more stable and a little bit more predictable than interest rate risk.
"It is not a matter of should I have any high-yield bonds in my portfolio any more, the question is how much," he concludes. "This idea that certain asset classes aren't for certain types of investors, people need to get over."
Today many investors do not hold enough equities in their portfolios and have a heavy "hometown" bias with Canadian stocks predominating. That mindset is understandable, says Raj Kothari, a partner and national asset management practice leader with PricewaterhouseCoopers LLP in Toronto. "Peoples' insecurity, lack of trust in the markets and what happened to them in 2008 is still fresh." That can be seen in a greater willingness to invest in tangible assets such as homes and money steered to fixed-income investments rather than equities.
Perhaps the greatest risk to the average Canadian's retirement savings plan is short-term thinking. Investment news – which focuses on the most imminent threats to the markets (the latest worrisome news from Greece, Cyprus or China, for example), analysis by industry experts or company news – is mostly transitory. It may or may not have an effect on your investments, but chances are that it will be short-lived.
The modern pace of communications conditions people to overreact to threats, hence the overexposure to bonds, and wind up with an asset mix that does not meet their long-term retirement goals.
One way to avoid the short-term or reactive investment trap is to invest like a pension fund, advises Adrian Mastracci, portfolio manager with KCM Wealth Management of Vancouver. "They think in decades, not in months, not in days, not what happens next week," he says. "That shift has to take place for the individual investor to really have their investments deliver what they require for the longer term."
It sounds boring when the industry seems to be producing the next and greatest exchange-traded fund or exotic investment product, but people need to create a coherent retirement plan and draw up an asset mix based upon that.
It is a problem Mr. Mastracci sees regularly, recounting a recent visit from a first-time client. "They had two advisers before, there is no game plan at all, there is no asset mix," he says. "If you look at what they have got [in his portfolio] there is just a whole variety of stuff."
Besides thinking long term and sticking to a mix of assets, another admirable trait of pension plans that average investors should strive to emulate is their approach to risk, says the Vancouver-based portfolio manager. "They resist that temptation to incur more risk. They don't throw darts" on speculative plays or load up on flavour-of-the-day investments.
Budget for 30 years
It is said that landing is the trickiest part of flying an airplane, so it makes sense that the final years leading up to retirement can hold the most risk. Just like touching down on the runway, there are plenty of variables one has to keep track of in those last years of transitioning out of the working world incident free.
"You have to be aware of the spoilers of your financial plan," said Mr. Mastracci. The Vancouver-based adviser notes that with people living to 85, 90 or beyond, a robust retirement portfolio needs to provide income for three decades or more.
Over such a long period, there are plenty of variables that could throw you off course: inflation, low returns, a long life, a large financial loss, existing debts or health issues. What I'm asking people to do is not so much worry about these things, but think about how they can minimize any effects of them," he said.
Planning for a long period of high inflation or low returns in the future, for example, may mean people would want to reduce monthly withdrawals from their nest egg during retirement or prompt them to sock more into savings in years leading up to retirement.
Mr. Mastracci's firm uses a proprietary retirement calculator into which its advisers can plug in variables such as one or both spouses living to 90 or beyond to come up with the required capital for a projected retirement. "Our normal planning is a 30-year window," he said. "Then we come back and say here is what you need to deliver on your expectations for the next 30 years."