You have seen the advertisements. We are urged that, as we get older, we should adjust our assets because time is not on our side. Should people adjust their asset mix as they approach retirement?
According to conventional wisdom, older people should favour fixed income investments (such as, bonds, bond funds, guaranteed investment certificates) as they age. In other words, they should shift investments away from equities. This wisdom is based on the belief that they need to generate an income from their investments and that fixed income investments are less risky than equities. This advice sounds reasonable; however, we often overlook the concept of volatility.
Bonds sound safe, but as interest rates move up and down, bonds can sometimes have greater swings in their value than stocks. For example, if interest rates for five-year Government of Canada Bonds should rise from 2% to 4%, the capital value of the bond will fall by 10%. Relying only on bonds in an effort to reduce an investment portfolio’s risk could be dangerous, especially during times of rising interest rates.
Guaranteed investment certificates (GICs) often disappoint investors because returns barely cover inflation. There is also a third negative: a heavy tax rate is applied to GIC (and bond) interest, which is fully taxable when held outside registered plans (such as, a RRSP or TFSA). Dividend income and capital gains income, on the other hand, are subject to reduced tax rates. Shifting your non-registered portfolio asset mix to more heavily favour fixed income investments will result in you paying more taxes.
A portfolio that includes an equity component may be the best investment approach, regardless of age. Equity investments provide a basis for investment growth; a factor needed by investors of all ages to maintain the purchasing power of their capital.
The conclusion is that a balanced and diversified portfolio is the most effective strategy to achieve long-term investment income and reduced volatility, at any age. Before people make investment choices based upon asset mixes determined by age, they should also consider other issues such as their long-term intentions for their investment, their target retirement date, tax rates on various investments, their personal risk tolerance and any pension income, especially via defined benefit plans. It’s not just age that should determine our asset mix.
Contemplating a move to cash equivalent investments? Let history be the judge. Take a look at this graph. Click the button below to view it.View
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