Should you invest internationally?

Federal finance minister Ralph Goodale caught everyone by surprise when he announced in his February budget speech plans to scrap the foreign content limit in registered plans. Even the mutual funds industry, which had been lobbying unsuccessfully for years to have this happen, was stunned by the immediacy of the decision.

Legislation to implement the change had not been passed by Parliament at the time of writing but from the perspective of the individual investor, that doesn’t matter. Traditionally, the Canada Revenue Agency (CRA) treats all budget announcements as having become effective on the date stated by the minister. In this case, Goodale said the rule was abolished “as of 2005,” which effectively means Jan. 1.

So you’re now free to invest as much of your RRSP or RRIF as you want in foreign securities. But should you? Not necessarily. In fact, for many older people, such a move would be a bad idea.

The advantages
There are two major pluses to international diversification. One is that it allows you to participate in the growth of economic sectors that are underrepresented or do not even exist in Canada. We have no indigenous automile manufacturing companies. We are not represented among the world’s leading pharmaceutical companies.

We do not have any entertainment companies that compare with Sony, Disney or Time Warner. We have no giant defence contractors, no consumer products firms on the scale of Procter and Gamble, no great travel companies such as Carnival Cruises and Cendant. If you confine your securities to this country, you would miss out on all this and more.

The second advantage of foreign investing is that it allows exposure to rapidly growing markets such as China, Brazil and India, which are expected to outpace the G7 countries. But therein also lies one of the risks.

The disadvantages
These markets are notoriously volatile and tend to display exaggerated boom-bust cycles. A younger person can afford to ride out the tough times with a view to obtaining above-average returns over a period of many years. But anyone at or near retirement age would be ill advised to add this degree of risk to a portfolio.

If we were to experience another Asian market shock along the lines of 1997, it could take several precious years to recover. You don’t have that luxury of time.

Another danger is currency risk. The past two and a half years have seen a remarkable recovery in the value of the Canadian dollar. In 2002, it looked like it was going to fall below $0.60 US, and a few economists were predicting it would drop to $0.50 US. At that point, the loonie started a remarkable turnaround, which, at the time of writing, sees it trading at $0.83 US. Economists have changed their tune, and some now predict a $0.90 US loonie by year-end.

A strong dollar is great for national pride and makes winter vacations in the sun a lot cheaper. But it erodes the value of any U.S. dollar securities you may own. In 2003, our dollar gained more than 20 per cent against the American greenback, wiping out all the profits any Canadian made that year on Wall Street.

Consider your plans first
If you plan to spend most of your retirement time in Canada, you cannot afford to take that kind of currency risk. Your goal is to preserve your buying power in Canadian dollar terms so most of your RRSP/RRIF assets should be held in Canadian securities.

However, if you plan to spend a significant amount of time in the U.S. as a winter snowbird, it’s a different story. In that case, you want to ensure that part of your assets are in U.S. dollar investments so that your American purchasing power will remain intact if the loonie suddenly starts to tumble again.

I also know of some Canadians who have chosen to retire in the south of France, Spain and Italy. If that prospect appeals to you, then invest some of your retirement money in euro-denominated securities (or sterling-denominated if the U.K. is your destination).

In short, be practical. Think through your retirement priorities carefully and then make any adjustments to your RRSP/RRIF on that basis. Don’t blindly follow someone else’s formula; your needs may be quite different.