When central interest rates rise, it won't just be homeowners feeling the squeeze - retirees' portfolios will also be in for a shock. Those approaching their golden years are often advised to shift a larger portion of their portfolio to less volatile investments, such as bonds. While these investments provide a generally stable appreciation, rising rates can spell trouble. When will rates rise? The official answer: eventually. Although inflation is back on track at 2%, economic pundits still don't expect to see a rise in the overnight lending rate until at least mid-2015.
Canadians Don't Know How To Protect Portfolios
Most Canadians are aware of the impact of rising rates on their portfolios - and they'd like to take steps to protect themselves. They just don't know how, according to a recent study by AGF Management. While seven in 10 are worried they haven’t saved enough for retirement, six in 10 admitted to not taking the necessary steps to protect their portfolio against the threat of rising interest rates. What’s the reason? It’s simply because we lack the knowledge. In fact, the majority of Canadians (71%) said they are somewhat or not at all knowledgeable about investing.
Canadians Worry Savings Will Run Out
Canadians are also living longer than ever before in retirement, leading to higher levels of anxiety regarding retirement savings. "We know people are not saving enough for their retirement and may not be prepared to deal with future market volatility. What this survey shows is that a growing number of Canadians recognize these as important issues and want to address them," said Blake C. Goldring, chairman and chief executive officer of AGF Management Limited. "Financial literacy and financial advice are the best tools to employ in these circumstances and these survey results indicate that Canadians recognize the value of both. Our industry is critical to the long term financial success of Canadians and we have a great opportunity to reshape how investors approach savings and how they think about risk."
How To Safeguard Your Investments Against Rising Rates
We've been spoiled for some time in today's low-interest-rate environment - it's a good time to take action against the possibility of rising rates. Remember that bonds and interest rates have an inverse relationship – when interest rates rise, bond prices fall. Keeping this in mind, investors can protect their investment profile in any number of ways - and the answer doesn't always lie in longer-term bonds. “Many fixed-income managers look to diversify through the traditional tools of duration, term structure, credit quality and category allocation," says David Stonehouse, vice-president and portfolio manager at Acuity Investment Management Inc. "Longer-term bonds can offer higher yields, but their prices are more susceptible to interest-rate changes. Other fixed-income categories such as high-yield bonds and convertible debentures can help manoeuvre portfolios through different market scenarios.”
AGF Management offers the following investments to safeguard your portfolio against rising rates.
High-yield bonds: High-yield bonds can provide potentially higher yields than government bonds and help diversify fixed-income portfolios.
Floating-rate notes (FRNs): These are attractive when interest rates are expected to rise because the interest rate of the bond is linked to the market’s interest rate. When interest rates rise, the bond’s interest payment (coupon) increases, protecting the investor. In contrast, bonds with fixed coupons lose value when interest rates rise.
Real-return bonds (RRBs) or Inflation-linked bonds (ILBs): These guarantee that an investor’s returns are not reduced by inflation because the bond’s principal amount is adjusted to reflect the changes in inflation, so they are worth considering when inflation is present or expected to rise. They can be purchased directly or as part of a diversified fixed-income mutual fund.
Equities: Another way to beat inflation is to invest where your money will grow faster than the rate of inflation. History has proven that stocks outperform inflation over time. Over the past 20 years, the average inflation rate in Canada has been 2% while the average annual performance of the S&P/TSX Composite Index was 11.0%. By investing in dividend-paying stocks during an inflationary environment, you can receive a steady income stream that can help outpace inflation as well as have growth potential. Keep in mind that investing in common stocks involves a higher risk tolerance than fixed-income investing.