Income securities and your RRSP
Fixed-income is still accurate when applied to bonds, GICs and the like. You invest a certain amount of money for a period of time at a set rate of return. Fair enough.
But the low interest rate environment has spawned a plethora of new income securities with returns that are anything but “fixed”. These include royalty trusts, income trusts, real estate investment trusts, limited partnerships, and all kinds of other clever instruments. They were created to fill a market void – an income investment that provided a higher rate of return than was available through the conventional interest-bearing securities of the past.
So we need to amend the name of this asset class. The easiest way to do it is to drop the “fixed” preface. Henceforth, these will be known simply as income securities. The list of eligible candidates for inclusion in this category is extensive. It includes those securities already mentioned as well as preferred shares, mortgage-backed securities, some dividend income funds, income trusts mutual funds, and more.
Every RRSP should have an income component to it. The percentage of the plan devoted to this asset class will vary depending upon the indivual. But as a general guideline, the range should be from 20% (younger, aggressive investor) to 80% (conservative, income-oriented retiree). Most people should consider an income component in the 30% – 40% range.
The problem is where to put that money, especially in today’s conditions. There is no universal “right” answer, but here are some ideas that may be helpful.
Long-term money. If you already have some of your RRSP money invested in high-grade income securities, you may decide to leave well enough alone. Don’t worry about the short-term prospects for the bond market. These too will pass away. Let me give you a personal example. Many years ago, we began to invest in the Phillips, Hager & North Bond Fund in my wife’s RRSP. We added to the position over time, and never sold any units even when the prospects for the bond market looked lousy. We accepted any short-term pain for long-term gain and stability. Over the past decade, we’ve been rewarded with an 8.7% average annual return. That’s not the best in the Canadian bond category, but it’s well up there. And it’s a very acceptable figure for the income component of Shirley’s RRSP.
The message is simple: if you don’t want to worry about interest rate movements and bond price fluctuations, you’re in for the long haul, and you want to keep things simple, then find a good general purpose bond fund for your RRSP and stay with it.
Short-term money/new contributions. If you don’t like the thought that the new bond fund units you buy now may decline in value over the next year (however temporary that may be) you’ll need an alternative strategy. There are two possibilities.
The conservative approach is to choose low-risk income securities. These would include short-term bond funds such as Altamira Short-Term Canadian Income, mortgage funds, a bond ladder going out no longer than five years, etc.
The aggressive strategy is to use the stock market as your income vehicle. For example, invest in an income trust that is based on a portfolio of equities but is designed to generate substantial cash flow.
The middle ground is a blend of conventional income securities (e.g. bonds, bond funds) with some REITs and income trusts funds. Here’s what the income component of an RRSP that adopts such a middle ground might look like.
GICs, short-term bonds/funds: 20%
Mortgage-backed securities, mortgage funds: 20%
Mid-term bonds, regular bond funds: 20%
Foreign bond funds: 20%
Income trusts/funds: 20%
This mix provides downside protection while at the same time offering upside potential and enhanced cash flow through the income trusts component. It also provides a currency hedge in the foreign bond funds which will come to your rescue if the loonie drops further.
You can juggle the numbers to meet your specific needs. The point is that unless you’re content to simply put the entire income component into a good bond fund and just let it sit, you need to give some careful attention to this side of your RRSP.
Adapted from the Jan. 28, 2002 edition of the Internet Wealth Builder, a weekly e-mail investment newsletter featuring some of Canada’s leading financial experts.