The trauma of 2008-09 forgotten, investors are once again acting like bank stocks can do no wrong.
A reader of retirement age with a good pension told me recently he has 95 per cent of his investments in stocks, much of that in Canadian banks providing him with a yield of about 5 per cent.
His question: “These banks have never suspended dividends that I know of, so why would I invest in bonds that might pay 2 per cent?”
If there’s a case for using bank stocks for income and not holding bonds, it’s this investor.
With a solid pension, he can afford to take risks in his stock portfolio in the pursuit of higher yields than he’d get in bonds. But let’s remember why investors hold bonds in the first place. It’s less to generate income than it is to stabilize portfolios when all hell breaks loose.
If you want to see what all hell breaking loose looks like, use the stock charts on Globeinvestor.com. Suggestion: Get yourself a 20-year view of Bank of Montreal (BMO) or Canadian Imperial Bank of Commerce (CM) shares and zero in on the huge dip between spring 2007 and winter 2009. Be honest with yourself – would you be fine to hold your bank stocks through carnage like that? If you really believe the answer is yes, then you’re a candidate to hold bank stocks instead of bonds.
Bonds – government bonds in particular – were a portfolio life preserver in the financial crisis. The FTSE TMX Canadian Bond Index gained 6.4 per cent in 2008. With bonds in your portfolio, you would have been less stressed at the height of the crisis and less likely to disrupt a soundly built portfolio for emotion-driven reasons. With bank stocks instead of bonds, you would have watched your portfolio crumble in the near term.
Canadian banks maintained their dividends during and after the crisis and their shares have soared since then. So let’s not bother arguing whether banks stocks are a great holding because they are. The real question is whether you have the guts to stick with them when all hell breaks loose. If you think maybe not, hold some bonds.