While debt-burdened Canadians cheer the latest interest rate cut from the Bank of Canada, investors are slowly running out of safe options to save for retirement.
This week, the Bank of Canada’s benchmark borrowing rate was lowered by one quarter of a percentage point to 4.5 per cent; the second consecutive quarter-percentage-point cut.
Economists at CIBC expect further cuts to bring the central bank rate to four per cent by October in an effort to stimulate lackluster economic growth.
Rewards for savers are drying up
Some Canadian financial institutions are still offering yields on fixed income such as bonds and guaranteed investment certificates (GICs) above five per cent, but the days of generous payouts are coming to an end.
In a social media post, chairman and president of Toronto-based Baskin Wealth Management, David Baskin, said he expects income-hungry investors to gravitate back to dividend stocks.
Right now the old Canadian dividend stalwarts such as the big banks are offering yields above five per cent.
Dividend stocks are a risky income alternative
But when it comes to saving for retirement, the volatility of dividend income is no substitute for the safety of fixed income.
As the term implies, a fixed income payout is essential at maturity for those in, or nearing retirement to ensure they can meet day-to-day expenses.
In contrast, dividend investors are exposed to the whims of equity markets and the big Canadian bank stocks have taken it on the chin this year.
At last check, the share price of Toronto-Dominion Bank has lost over seven per cent of its value since the beginning of the year despite an annual dividend payment of over five per cent.
Shares of Bank of Montreal are down by over eight per cent this year as shareholders are compensated with a 5.2 per cent dividend.
Those high dividends are cold comfort for investors who can’t afford to wait out a downturn and need to sell beaten-down stocks to pay their bills.
The big Canadian banks have a long history of never cutting their dividends but it’s important to know payouts are at the discretion of the companies that issue the shares, which makes them far from fixed.
Sacrificing yield for safety
The good news is that fixed income will continue to reward savers to a lesser degree and it doesn’t appear interest rates will return to the near zero days of the previous decade.
In most cases, it’s good to hold a significant portion of a portfolio in fixed income, regardless of yield.
That gives investors looking for more security the option of allocating more of their assets to fixed income and still meet returns goals.
The right mix between fixed income and equities depends on the individual investor but a qualified advisor can help formulate strategies to maximize fixed income returns by staggering maturities within a portfolio to take advantage of the best going yields as often as possible.
The most common strategy, known as laddering, ladders maturities over a fixed period of time.
A general rule is to allocate a percentage of your portfolio to fixed income equal to your age. In other words; if you are 50 years old, half of your portfolio should be in fixed income. It’s a way to automatically reduce equity risk as you age.
Opportunity from a weak loonie
One potential benefit for retirement investors from the Bank of Canada being the first major central bank to cut rates is the resulting downward pressure on the Canadian dollar compared with the U.S. dollar.
Investors who diversified to U.S. dollar denominated investments when the loonie was stronger could have the opportunity to convert the cash for more loonies.