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| Adrian Mastracci, president of KCM Wealth Management, says “Say someone had started a fresh 5-year fixed income ladder in mid-2000. Their average yield would have been approximately 5.3%. Now compare that to someone starting the same ladder today. The average yield would be around a paltry 2.3%, or about 57% less. That hurts." |
For Immediate Release
Vancouver, BC (October 8, 2004): If you had embarked on a cruise four years ago, never looked at the financial pages and came back today, you would not believe your eyes. I know, you wished you had done just that. The Thanksgiving celebration might be a little subdued.
You see, some painful changes have occurred in the world of interest income yields during the cruise.
Adrian Mastracci, investment counsel at Vancouver's “fee-only” KCM Wealth Management, comments, “All categories of interest rates have been slashed, especially the shorter term ones. While this is terrific for borrowers, it’s been a real struggle for investors who depend on portfolio income.”
“The interest rate declines have affected all income portfolios,” Mastracci adds, “Personal and business accounts, RRSP’s and RRIF’s, pension funds and family trusts have all suffered the noticeable reduction in income. Investors in retirement are affected the most.”
“Income portfolios will have to adjust investment strategies to make the best of the current times,” says Mastracci, “Just examine the rates below to get a sense of the painful declines.”
Pain and suffering
Mastracci illustrates the interest rate cuts since mid-2000:
| Rate Date |
1-Year Rate |
2-Year Rate |
3-Year Rate |
4-Year Rate |
5-Year Rate |
| July 6, 2000 |
5.00% |
5.25% |
5.30% |
5.35% |
5.55% |
| October 7, 2004 |
1.35% |
2.05% |
2.40% |
2.70% |
3.10% |
| Rate Change |
-3.65% |
-3.20% |
-2.90% |
-2.65% |
-2.45% |
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NOTE: The above rates are from the same institution for non-redeemable Guaranteed Investment Certificates, paying annual compound interest, minimum investment of $1,000.
“Say someone had started a fresh 5-year fixed income ladder in mid-2000. Their average yield would have been approximately 5.3%,” observes Mastracci, “Now compare that to someone starting the same ladder today. The average yield would be around a paltry 2.3%, or about 57% less. That hurts.”
“This decline demonstrates the significant impact inflicted on income portfolios in a short time,” points out Mastracci, ”Fixed income yields have declined considerably in four short years.”
“The yields on other fixed income investments, such as government and corporate bonds, have also slipped over the past four years,” notes Mastracci, “Not to mention yields on savings accounts.”
“Clearly, this has affected, and will continue to affect all retirement plans,” indicates Mastracci, “Investors now contemplating retirement are concerned about the path they are about to embrace.”
“On the other hand, those investors who have held bonds since mid-2000 are extremely happy,” quips Mastracci, “Yes, those boring bonds have provided a nice capital gain.”
“So what is an investor to do under the present climate,” asks Mastracci, “Especially, as interest rates are expected to rise from current levels.”
Potential remedies
Mastracci offers these comments for income portfolios:
1. First, review the investment expectations. Re-assess all investment policies and strategies to reach the chosen goals. The fixed income component is the stable part of the portfolio return. Therefore, make sure that the income generating portion is prudent for the situation.
2. Studies show that asset mix decisions have the greatest impact of any factor on portfolio returns. If asset mix is not the focus in the investment portfolio, it ought to be. The fixed income portion is an important consideration in achieving a diversified portfolio within acceptable risks.
3. A ladder of interest rate maturities offers protection against the ravages of interest rates. Review the investment time horizon when structuring a ladder of interest rate maturities to match portfolio needs. Right now, a prudent ladder is likely not more than 4 to 5 years in duration.
4. Investors who hold large cash resources in short-term instruments often wait too long before they initiate suitable investments. Examining the appropriate steps to achieve a variety of suitable maturities assists the plan and improves investment returns.
5. Investors contemplating retirement, or in the midst of it, ought to be careful about choosing instruments that offer low quality. While the increase in yield is tempting, it may not be sufficient compensation for the added risk. Investment guarantees, if any, may also be compromised.
6. Be aware of the risks of over indulging on alternative investments, such as income trusts. Yes, the yields are tempting, but they too are subject to price declines as interest rates rise. They are really equities and there is nothing guaranteed about them.
“The fixed income strategy, especially during lean interest rate periods, is important for a portfolio’s financial health,” summarizes Mastracci, “It is especially critical for a retiree who relies on the portfolio to provide ongoing income needs.”
“Saving more for retirement is a higher priority for many,” concludes Mastracci, “While the dismal fixed income yields are expected to rise, time is required before meaningful improvements likely occur.”
Happy Thanksgiving.
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