June 2015

Vacation at last!
Is your portfolio really diversified? How soon should you start investing?
This month’s challenge… Check out this month’s finds...

Search the archives

The front page

The cost of security

The cost of security

After a decade of generally positive returns on the financial markets, and with persistent rumours of an economic slowdown, many investors seem inclined to turn to “safer” investments. But at what cost?

According to the latest figures from the Investment Funds Institute of Canada (IFIC), bond-based mutual funds* accounted for more than half of all mutual fund sales in Canada last July. In fact, from January to July, Canadian investors reportedly invested nearly $10.5 billion in bond mutual funds, while withdrawing about $5.4 billion from equity funds.

There might not be an actual flight-to-safety in progress, but it would seem that the income-oriented investments considered to be less volatile are currently in demand – which could also raise this question: What compromises are we making when we choose safety?

Compromise Number 1: Returns

By turning to defensive investments, such as guaranteed deposits or bonds, at the expense of capital growth investments such as equities, investors might have to lower their expectations for returns.

This choice could have significant consequences over the long term. As illustrated by the following graph, a recent study by the World Economic Forum found that, on average, residents of major industrialized nations would not have sufficient personal savings to generate income throughout their retirement years. And according to analysts, this can largely be explained by a tendency to favour defensive securities too early in life.

 

Bar graph showing the growth of savings in an RESP where the contribution is $2,500 per year, enough to maximize the Canada Education Savings Grant. The calculation is based on a student in Ontario and assumes an annual average return of 4%. The resulting curve shows that capital accumulation will be more than $60,000. However, given the cost of education, a shortfall is shown by the third year of studies: there is no longer enough money to finance the remaining years of education.

 

Compromise Number 2: Inflation

A second compromise could be what is known as “inflation risk.” Put simply, this is the possibility that the return on investments might be lower than the increase in the cost of living, year after year. As a result, even if people are saving a considerable amount, their buying power is decreasing and they are, in fact, getting poorer.

Compromise Number 3: Liquidity

Many investments with a guaranteed return also have a maturity date before which the capital cannot be withdrawn. For example, this is the case with guaranteed investment certificates. In the event of unexpected needs – associated with health problems, for instance – the fact that these investments are not as liquid as others could be a problem.

Compromise Number 4: Risk in unexpected forms

Finally, another price to pay would be that fixed income investments can actually involve some risks. In the case of bonds and bond funds, the main one is interest rate risk: depending on whether rates decrease or increase, the value of a bond portfolio may rise – or fall. As well, any guarantee underlying fixed income securities is linked to the stability of the issuing institution.

Possible solutions?

Investors looking for another form of compromise may wish to consult a professional to consider some alternative approaches.

One such alternative could be to opt for a portfolio of funds where the asset allocation is determined by the holder’s risk profile, i.e., both the level of risk needed to reach the person’s objectives and his or her personal tolerance for volatility. In this type of fund, the asset allocation is periodically rebalanced to reflect changes in the markets, without the investor having to worry about it. There are also products known as “target date” funds, where the asset allocation is gradually adjusted as the person ages and his or her investment horizon decreases, so that the investor is exposed to less and less volatility. Finally, there are investments where the returns are linked to market performance, but the capital is guaranteed.

For more information, contact your mutual fund representative or financial security advisor.

 

* Mutual funds are offered through mutual fund representatives associated with Desjardins Financial Security Investments Inc. or SFL Investments Financial Services Firm.

 

 

The following sources were used to prepare this article:

Actualis,Portfolios of funds at a glance”.
Bankrate,8 best low-risk investments in September 2019”.
Finance et investissement,Les ventes de fonds obligataires cartonnent”.
Get Smarter About Money,Inflation” ; “Risks of GICs”.
MacroTrends,S&P 500 Historical Annual Returns”.
Morningstar,5 portfolio lessons from target-date funds”.
Seeking Alpha,The Investor's Survival Guide To A Long Life”.
The Balance,Do Safe Investments Carry Risks?”.
Wikipedia,Fund of funds”.
Wikipedia,Target date fund”.
World Economic Forum,White Paper – Investing in (and for) Our Future”.