Equities vs. Bonds

Written by Managing Partner
Brett Millard
Summer 2012

Conventional wisdom dictates that bonds are fairly safe and equities or stocks are risky – however, we don’t live in conventional times. With the current volatility in the equity markets, hundreds of thousands of investors are pulling their portfolios out of the equity markets and transferring them to the “safe haven” they see as bonds and GICs. Unfortunately, most of these investors don’t realize how bad of a decision that really is.

Baby boomers in particular are making this devastating error and are putting their retirement income at serious risk. With GIC rates hovering around 2%, these retirement portfolios are actually losing money each year after taxes are paid and inflation is taken into account. For example, let’s say you place your investment into a 2 year GIC that pays out 2.2% per year. If you then pay ½ of that growth to taxes and factor inflation of 2% into the mix, your net return is -1% each year!

Equities are well priced right now and there is a lot of great “bargains” out there. On average, stocks are trading at about 25% below the long term average. Of course, the reason that they are so cheap is that there are plenty of things to be worried about. Every period of time that’s been this cheap has also been extremely volatile. In short, if you have the stomach to handle the market swings, you will be in a good position to make money. Having said all that, if you’re risk tolerance level is not up to taking this on; lower volatile options must be used.

Does that mean you should be 100% invested in equities? Certainly not (well at least not for most of you)! There is a very wide variety of conservative equities, preferred shares and even high yield corporate debt options that can boost your portfolio’s performance without taking on too much risk. It’s important to research the individual investment options and find out what’s right for you.

Why not just buy an “ETF” or exchange traded fund? “My neighbour/hairdresser/taxi driver told me it’s the way to go.” In these volatile times more than ever, active fund management can mean all the difference in the world. I had a client come in and tell me their friend had recommended they move out of their existing dividend focused mutual fund over to a TSX index based ETF. When I asked why this was recommended, there was no real answer and I then took the time to explain the differences between active management and index tracking. The Canadian Equity Dividend fund that the client is in is up +1.25% so far in 2012 and charges an annual management fee of 1.87%. A TSX based ETF was showing a 2012 YTD of -2.5 and charges an annual fee of 0.5%. By saving approximately 1.37% a year in management fees, the client would be losing on 3.75% of investment return.

So what are you supposed to do? Each investor’s situation is unique and there’s no blanket answer for everyone. The mass exodus that we’re currently seeing from equities to bonds and fixed income is not the safe play that many think it is. Although investing in these turbulent times is tough on most of us, it’s vital to your financial future that you don’t panic and make a bad decision that can sabotage your retirement.