Searching for the perfect investment
It’s Christmas Eve and the first night of Hanukkah. In the spirit of the season, I’ve been doing a lot of research in an effort to find the ideal gift for readers: the perfect investment.
I know a lot of people are searching for it, because I keep getting emails asking me for a risk-free security that guarantees an annual return of 5 per cent, or 8 per cent, or whatever.
What better gift could I give at this festive time than a recommendation that meets those criteria?
Unfortunately (but not surprisingly), I came up empty. In fact, there was nothing that I could find that even came close to meeting those conditions.
Let’s face reality: all securities are flawed in one way or another. It’s left to each of us to decide which defects we can live with and which are unacceptable.
That’s even more important now because the investment landscape is changing before our eyes. We’re looking at a new set of realities caused in part by the election of Donald Trump and in part by shifts in the global economy. How you respond will depend on your investment priorities.
I believe there are only three basic types of investors. Each of us needs to decide which group we belong to and make our financial decisions accordingly. Here they are.
The safety-first investor. For these folks, preservation of capital is the No. 1 consideration. They don’t want to lose any money, period. If you’re in this category, these are very dangerous times. U.S. stock markets are near record highs and by some standards seriously overvalued. World bond markets are in sharp decline. Inflation may be about to stage a comeback after years of dormancy, threatening the purchasing power of currencies.
Most important, no one knows what to expect from the incoming U.S. administration. The next six months, and maybe longer, will be a time of deep uncertainty, during which investors may react in unpredictable ways. As we have already seen, individual stocks can spiral up or down in minutes, depending on the president-elect’s latest tweet. Imagine the impact every careless word will have when he’s actually in the White House.
Risk-averse investors won’t want to expose themselves to the market gyrations that are sure to come. But what is the alternative? It appears that the 30-year bond bull market has finally come to an end. The U.S. Federal Reserve Board raised its benchmark rate by a quarter point this month and predicts three more hikes in 2017. That has driven up commercial lending rates both in Canada and the U.S. and hit bond prices hard.
After a strong start to the year, the FTSE Russell Canadian All-Government Bond Index is down 1.59 per cent for December as of the time of writing, pulling it into negative territory for 2016. One of the few bond sectors that continues to show positive returns is high-yield issues, which are up 0.71 per cent for the month and an astounding 15.8 per cent year-to-date. But no truly risk-averse investor wants to put a lot of money here. These securities didn’t earn the name “junk bonds” for nothing.
So what can I suggest for a safetyfirst investor? The best solution I can find is a cashable GIC. It’s not smart to tie up your money for several years when interest rates are rising, but a redeemable GIC lets you get out before maturity if you wish. There’s just one catch — the interest rate you receive will be reduced if you exit early. Only a few financial institutions offer these GICs, one of them being a Manitoba-based credit union named Outlook Financial. It currently offers 2.3 per cent for a five-year certificate. If you cash out early, that rate is cut to 1 per cent, but at least your money isn’t locked in until 2022.
The income investor. The past few weeks have been rough on people whose main goal is cash flow. With markets anticipating higher rates and more inflation, the prices of interest-sensitive securities have been tumbling. As I write, the S&P/ TSX Capped REIT Index is down almost 10 per cent from its 52-week high, the Capped Utilities Index is off 5.8 per cent and the Capped Telecom Index had lost 7.3 per cent. If interest rates continue to rise in 2017 as projected, expect more of the same in the next 12 months.
It’s at times like this that you really need the courage of your convictions. None of these companies has cut its dividends/distributions. The cash is still flowing into your brokerage account. However, the market value of your securities has dropped.
That shouldn’t be important to a true income investor, but many people look at the bottom line on their statement, see a loss, and think they are doing something wrong. My advice is to forget about the market value for now. Accept that it may drift lower for the next few months and move on. Just keep an eye on the dividends. The companies that raise them in 2017 will be the ones that fare best in this climate.
The capital gains investor. If you are in this group, you’re probably very happy at this stage. Stock markets have been on a huge run and the rally doesn’t show any sign of ending. The major New York indexes all hit record highs this month and the TSX is getting close.
The question at this point is how greedy do you want to be? Market records always make me nervous — eventually stocks turn down and the pain can sometimes be excruciating, as it was in 2008. You want to take some money off the table before that happens. So I suggest you start taking some profits soon and build cash reserves for the eventual retreat. But timing is everything. From a tax perspective, it would be better to wait until the new year to sell if the securities are in a nonregistered account. That way, no tax will be payable until April of 2018.
Sorry I could not come up with the perfect investment idea this year. But hopefully these thoughts help make your decisions a little easier. Best wishes for a wonderful holiday season. Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters. His website is www.BuildingWealth.ca. Follow him on Twitter at twitter.com/GPUpdates