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IN THIS ISSUE, contributing CMS editor Dan
Bortolotti, an investment adviser with PWL
Capital in Toronto and the creator of the
award-winning Canadian Couch Potato blog
canadiancouchpotato.com), answers questions from Canadian MoneySaver readers.
Is it still a good idea to invest in bond
exchange-traded funds (ETFs) in a rising
interest rate environment? Would individual bonds be more appropriate?
Interest rates and bond prices have a seesaw relationship: When one goes up, the other
goes down. But that’s not a reason to avoid
bonds altogether: Only the most battle-hard-ened investors can endure the ups and downs of
a portfolio with no fixed income. When the
stock market falls hard (and that’s going to happen many times), bonds are the safety net that
will catch you before you abandon your long-term plan.
Individual bonds are not less risky
than ETFs. In fact, if you’re holding
individual corporate bonds you face
significantly more credit risk, and
you’re probably paying a high markup
when you trade the bonds. If you are
nervous or confused about what to
expect from bond ETFs, consider
building a ladder of guaranteed investment certificates (GICs) instead.
If I choose to set up an ETF portfolio by selling all my current stocks,
is it advisable to buy them all on
the same day or do it over a longer
Investing a lump sum is always
stressful, and it can be tempting to ease
into the market. But you may find you’re
turning one difficult decision (“is now
the right time?”) into three or four.
Remember that if you currently own
individual stocks, you’re fully invested in
the market already, so switching to ETFs
doesn’t really change your exposure. In
fact, moving to a more diversified portfolio of ETFs will actually reduce your
risk, so embrace the switch.
We hold 100 per cent of our fixed income
in Canadian bonds. Should we add international bonds for more diversification?
Investors understand that they should
diversify their equity portfolios by adding U.S.
and international stocks. So why do most people keep all of their bonds in Canada? Holding
foreign bonds may expose you to currency
risk, and that isn’t something you want on the
fixed-income side of your portfolio. Bonds are
supposed to lower the volatility of your portfolio, but currency risk may cause your bond
holdings to experience double-digit losses or
gains, which means more volatility, not less. If
you do include a global bond fund, be sure to
choose one that uses a strategy called “
currency hedging” to reduce this risk.
How does one’s time horizon affect one’s
choice of ETFs? I have a Registered Disability Savings Plan for my son that he will
not access for 35 years. Can I invest it all
A portfolio of 100 per cent equities has a
higher expected return than a balanced port-
folio that also includes bonds. And with a time
horizon of 35 years, you have plenty of time to
ride out any turmoil in the stock market.
But that’s not the whole story. The more
important question is, can your stomach handle an all-equity portfolio? If not, you are at
risk of selling your stocks in a panic during the
next bear market. During the 2008–2009
financial crisis, even diversified equity portfolios lost between 40 per cent and 50 per cent
in about six months, and many investors
bailed out of the market. Some sat on the sidelines for years, missing the dramatic recovery
that followed. Don’t make the mistake of overestimating your tolerance.
Can I use real estate investment trusts
(REITs) and preferred shares for the fixed-income portion of my portfolio?
Other income-producing investments,
such as REITs and preferred shares, have a very
different risk/return profile, and they are not a
substitute for bonds. During turmoil in the
equity markets, REITs and preferred shares
can fall sharply along with stocks, so they offer
little diversification benefit when you need it
most. Bonds, on the other hand, are likely to
stay stable, and often increase in value during
these periods. Their expected returns are low,
but that is the price of safety. C
Tips on bonds