How to get de­cent re­turns in a world of stock mar­ket volatil­ity

ZOOMER Magazine - - CONTENTS - By Gor­don Pape

Gor­don Pape

“I have around $5,000 to in­vest and I would ex­pect to get at least seven per cent an­nual re­turn on it. Where and what can I in­vest in?” –HH

IHAVE RE­CEIVED ques­tions like this so of­ten over the years that I have long since lost count. The one thing I have no­ticed is that peo­ple have be­come a lit­tle more re­al­is­tic in their ex­pec­ta­tions. They used to want 10 per cent. Now it’s down to seven or eight per cent.

But even those lev­els are un­achiev­able un­less you’re pre­pared to take some risks. There is no free lunch when it comes to in­vest­ing. No one gives away money.

I can tell you how to earn 2.3 per cent risk-free. Just open a high-in­ter­est ac­count with EQ Bank, an on-line in­sti­tu­tion. At the time of writ­ing, that’s the rate they were of­fer­ing, and your money is pro­tected by the Canada De­posit In­sur­ance Cor­po­ra­tion up to $100,000. They also of­fer a five-year guar­an­teed in­vest­ment cer­tifi­cate (GIC) that pays 3.6 per cent and is also cov­ered by de­posit in­sur­ance.

But that’s only about half the re­turn our reader is look­ing for. If he wants to stick with that tar­get, he has to ac­cept some risk.

One of the ba­sic prin­ci­ples of in­vest­ing is that the greater the re­turn, the more risk is in­volved. There was a time back in the early 1980s when you could earn 10 per cent or more on a GIC but in­fla­tion was run­ning in the dou­ble dig­its at that point. The risk was that in­fla­tion would keep ris­ing, erod­ing the pur­chas­ing power of your cap­i­tal in spite of the high re­turn.

To­day’s in­ter­est rates are low by his­toric stan­dards, although they have been ris­ing this year. In­fla­tion is 2.2 per cent (Septem­ber), which is well within the Bank of Canada’s tar­get of one to three per cent. That’s why you won’t find any seven per cent GICs around, nor will you any time soon.

So what’s the an­swer to our reader’s ques­tion? Let’s look at some pos­si­bil­i­ties.

BONDS These are usu­ally con­sid­ered safe havens for in­vestors, es­pe­cially gov­ern­ment is­sues. If the stock mar­ket crashes, bonds will cush­ion any losses. But when in­ter­est rates rise, the price of ex­ist­ing bonds tends to fall, leav­ing in­vestors in a loss po­si­tion. Over the six months to Sept. 30, the av­er­age Cana­dian fixed in­come fund de­clined 0.79 per cent in value. Short- term bond funds, which are lower risk, gained only 0.02 per cent, vir­tu­ally break-even. There is no rea­son to ex­pect the next year to be any dif­fer­ent.

PRE­FERRED SHARES These are gen­er­ally seen as lower risk than in­vest­ing in com­mon stocks. But in re­cent years the mar­ket has been more volatile than nor­mal. As of late Oc­to­ber, the S&P/TSX Pre­ferred Share In­dex was show­ing a five-year de­cline of 13.2 per cent. The sit­u­a­tion has been im­prov­ing, but the year-to-date re­sult was still in the red at that point. Yes, there are pre­ferred shares that of­fer yields that meet or bet­ter our reader’s tar­get – Bom­bardier Se­ries 4 (TSX: BBD. PR.C) is pay­ing 7.7 per cent as I write. But there’s a lot of volatil­ity here – over the past 12 months, the price has been as low as $17.65 and as high as $23.80. Most in­vestors don’t want to put their money in se­cu­ri­ties that fluc­tu­ate so widely in value.

STOCKS Here’s where seven per cent be­comes a rea­son­able tar­get, if you can deal

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