Conventional wisdom says that when it comes to investing for retirement your exposure to equities should equal about 100 minus your age.
That means a 30-something should have up to 70 percent of his or her portfolio in equities to help maximize investment returns over time.
Related: Building Your Investment Portfolio
As you get older you’ll dial back the risk so that when you’re close to retirement age you’ve reduced your equity exposure to about 30 percent of your portfolio.
All GIC Portfolio
But personal finance author and chartered accountant David Trahair says you can retire well enough without putting any of your money in the stock market. Instead, he suggests the best place for your savings is in ultra-safe GICs.
Trahair’s retirement solution is simple. Pay off your debts quickly, live within your means, and don’t make the type of investing mistakes that can derail your retirement plans.
That means avoiding high MER mutual funds and volatile markets that can lead to irrational behaviour – like selling when markets are falling and buying on market exuberance.
It’s hard to believe in this low rate environment, but GICs have held up remarkably well against the stock market over the long haul.
|Time frame||S&P/TSX Composite Total Return Index||GICs|
|10 years to Aug 31 2009||9.41%||3.35%|
|20 years to Aug 31 2009||8.86%||5.11%|
|30 years to Aug 31 2009||10.76%||7.28%|
|40 years to Aug 31 2009||9.77%||7.71%|
|50 years to Aug 31 2009||9.80%||7.35%|
Not only are GIC returns competitive with the overall stock market returns, they do so without the risk and without the fees that come with investing in equities.
- You’ll never see negative 30 to 50 percent returns from a GIC like you can with the stock market.
- When you take out the 2 percent MER from a managed fund you’re down to near GIC territory.
- To get the total market returns you’d need to be invested 100 percent in equities, which is unlikely.
According to Trahair, your emotions can have the biggest impact on your investment returns.
Were you able to hold on when your equities lost almost 50 percent of their value between June 2008 and March 2009?
Can you avoid the story stocks (Nortel, RIM) and IPOs (Facebook) that can quickly sink your portfolio?
So can you succeed with an all-GIC portfolio?
This strategy makes sense if you’re the sort of person who’s still putting money in high MER mutual funds and you’re not comfortable investing on your own, or if you absolutely can’t stand the thought of losing money in the market.
You can make up a lot of ground by eliminating your debt (including your mortgage) as quickly as possible and then ramping up your savings as you get closer to retirement.
You could argue that GIC rates are so low that you’ll need to be in the stock market in order to beat inflation. But Trahair doesn’t buy that argument.
I’m sure if you had $100,000 in 2008, you’d rather have $102,000 the next year with a GIC than have $70,000 in some equity mutual fund.
Besides, if inflation gets out of control it’s likely that GIC rates will also rise to keep pace.
Trahair suggests you avoid market-linked GICs, which claim to capitalize on the growth potential of the stock market without putting your principal investment at risk.
Like a traditional GIC, a market-linked GIC offers the peace of mind of 100 percent principal protection so if the markets go down you’ll still have your original investment.
But the upside is limited to about 4 percent a year, which isn’t enough of a premium over the best 5-year GIC rates, which currently sit at about 2.85 percent.
Trahair defies conventional wisdom by suggesting most investors would do better with an all GIC portfolio rather than investing in equities.
At first I dismissed this approach as being too conservative and simple to work. But there’s a strong case to be made that the majority of us should protect ourselves from our own mistakes and from falling prey to investment scams and unscrupulous advisors.
Consider that from 1991 to 2010 the S&P 500 Index averaged 9.14 percent a year, but the average equity fund investor earned just 3.83 percent a year.
Our irrational behavior often leads to poor returns because we tend to buy after the market goes up, and bail when it goes down.
We chase the latest trends and pay too much attention to what’s happening in the economy today without keeping an eye on the long term.
A strict diet of GICs is about as stodgy as it gets, but you might sleep better at night with this risk-free approach.
What do you think of Trahair’s argument?