Clark Wealth Management Group - ScotiaMcLeod Fredericton

Please note that next Monday is the deadline for making an RRSP contribution you can claim against income earned in 2009.

Two interesting and conflicting items caught my eye this week that I thought we’d look at today. First, statistics Canada confirmed that we are living longer. We continue to extend life expectancy by about 2 years every decade. As of 2007, on average a man aged 65 could expect to live another 18 years. A 65-year-old woman could expect another 21 years.

When we back out the 10 years of life expectancy gained since Canada’s government pension programs were established in the 1960s we get a sense of why there is so much concern about our public pension plans. The designers of those programs lived at a time when the average retiree lived about 7 years after they stopped working at age 65. Even if we don’t consider the probable higher costs of medical care in those additional 10 years of life, the cost of pension payments alone for that extra 10 years is a game changer for governments today.

When we overlay the demographic realties of the baby boomers, it is hard not to conclude that public pension benefits are going to go down or taxes are going to go up, or both. The corollary of course is that Canadians will have to accept more personal responsibility for funding their retirement. This leads me to the second observation we’ll look at today.

The evidence is clear that Canadians are buying a disproportionate amount of interest bearing investments like GICs, bonds, bond mutual funds, and balanced funds (that are about 40% invested in bonds) at what may be precisely the wrong time. Why is this the wrong time to be overweighting bonds in your portfolio?

1)      Interest rates paid on these investments are at generational lows.

2)      When interest rates rise as economic conditions normalize, the value of bonds will go down creating potentially significant losses for investors. The longer the term of the bond the more sensitive it is to interest rate changes.

3)      It’s a mathematical reality that Canadians have to save more and/or earn more on what they save if they are to be able to live their retirement dreams over what is expected will be a longer retirement. It’s odd then that they are buying so much of an investment type that if not done correctly could very well work against them in this regard.

Sadly, the fact that investors are investing a disproportionate amount of their money in arguably the wrong asset class to overweight now is not a new phenomenon. A study of the flow of investment money shows that throughout history investors have flocked to investments that have done well in the most recent historical period. 

Please don’t misinterpret this to mean that investors should not to have fixed income securities in their portfolio. For the vast majority of investors having some of their money invested this way is very prudent.

Diversification by asset class is an important part of risk management. It’s precisely for this reason that people should not get carried away and put too much of their money in any single asset class, including bonds.

By trying to avoid volatility in potentially higher returning investments some investors are setting themselves up for what may be big disappointments. Over the short term, longer-term bonds and longer duration bond funds are likely to produce negative returns as rates rise. Over the longer term, without an appropriate disciplined asset allocation and investment plan in place, retirement dreams may have to be adjusted to reflect the fact that there is less capital available than was expected.