How to keep your retirement nest egg intact

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It was a cruel summer for stocks. Disillusioned North American investors fled markets, while Bill Gross, founder of PIMCO, the world's biggest bond fund management firm, declared that "the cult of equity is dying."

Gross's jibe irked many mainstream investment advisers. Following Wharton finance prof Jeremy Siegel's lead, they've been preaching the gospel of equities: Government bonds and other safe investments won't build you a big enough retirement nest egg. Stocks provide higher returns. True, they are riskier, but over time, your risk of loss diminishes.

The trouble is that the trend hasn't held up over the past 30 years. Find the Globe Investor historical returns calculator on theglobeandmail.com, and you'll see that a representative portfolio of bonds has beaten stocks handily over the past one, five, 10, 20 and 30 years.

That's no surprise to Zvi Bodie, an outspoken finance professor at Boston University and co-author of Risk Less and Prosper. He argues that both history and statistical theory show that there is no guarantee that you will be rewarded with higher returns if you risk your money in stocks.

Let's deal with history first. Proponents of equities often point out that U.S. stocks have beaten bonds over each of the five 30-year intervals since 1861 except the last one. But Bodie says that, statistically, that's "too few independent periods to justify the conventional conclusions." Looking ahead, he acknowledges that expected average long-term returns for stocks are still higher than those for bonds, but an average is just that–one of a range of possible outcomes.

So what are investors supposed to do, especially the many baby boomers now nearing retirement with savings of less than $100,000?

For starters, Bodie argues that boomers with inadequate savings shouldn't swing for the fences by investing more heavily in stocks. "That person can't afford to take any more risks," he says.

Much of Bodie's advice is sobering. First, he says you should estimate the cost of needs in retirement, not just wants. Then build a base to cover those needs using low-risk investments. He recommends inflation-protected bonds. In Canada, Ottawa and several provinces issue real return bonds (RRBs), which adjust the principal and the interest coupon to the consumer price index.

But investors have bid up the market price of government bonds recently. Effective yields on many are now less than 2 per cent. Other safe investments, such as bank GICs, aren't much better.

Once you've covered your needs, you can turn to stocks for aspirational goals. Here again, though, Bodie urges caution. He likes so-called structured products–funds or securities that use leverage and derivatives to try to protect your investment and capture stock market gains, such as the principal-protected notes sold by Canadian banks. He acknowledges, however, that retail versions of those products are still in their infancy.

Seasoned investors might want to use options to limit losses. Say you owned units in the iShares S&P/TSX 60 Index Fund, a popular Canadian ETF, in early September, when it was trading at about $17.20 a unit. You could have built a floor at $15.50 by buying a put contract (available through major online brokerages). A put gives you the right, but not the obligation, to sell the ETF at a specified strike price–halting your loss if the market price of the ETF declines below that.

For a put that would protect you until Dec. 22, the price was 26 cents. If you wanted to offset some or all of that cost, you could have sold a call option. A call gives the buyer the right (but not the obligation) to purchase at a strike price. In August, you could have sold a call at $18 for 22 cents. However, if the market price of the ETF climbs, the buyer would capture all gains beyond $18.

Is all that effort worth it? Ultimately, Bodie argues, "the simplest way of reducing risk is to invest in safe assets."

Tip sheet

Jean Coutu Group Inc.

14: Forward price-to-earnings ratio

A recent CIBC analyst's report called this Montreal-based pharmacy business "the ultimate defensive stock." There's plenty to make cautious investors feel serene: The company has reduced its stake in the sluggish U.S. Rite Aid chain to 19.9 per cent, and revenues and earnings in its core markets in Eastern Canada are both up strongly. The quarterly dividend is a modest seven cents a share, but it's doubled over the past five years.

Exchange Income Corp.

223 per cent: Three-year revenue growth

When Winnipeg financier Mike Pyle founded a diversified income trust in 2004, he wanted to put together a mini-conglomerate of "old, boring, cash-generating businesses." It hasn't turned out that way. The result is a quirky and fast-growing combination of regional airlines serving northern First Nations communities and holdings in specialized manufacturing, including makers of storage tanks for fuel, water, wine and chemicals.