By Paul Delean

The Montreal Gazette
Saturday, July 19, 2003

The Vancouver Sun
Saturday, July 19, 2003

Victoria Times Colonist
Tuesday, July 22, 2003

Experts see big problems for Canadians who have overextended during current credit boom.

If you're thinking of buying a first home or moving up, your banker has a deal for you -- the lowest lending rates in decades.

The bad news is that housing prices are sky-high, largely because of greater mortgage affordability and increased consumer demand.

That's the dichotomy of low interest rates (which got even lower this week with a quarter-point cut in the Bank of Canada's overnight lending rate). While there are definitely benefits to consumers, particularly those carrying, contemplating or renewing debt, there are also drawbacks. What you gain from one source can be taken from you by another.

If your house goes up in value, so will your taxes, whether or not you have any interest in moving.

If you buy a new car, interest rates may be negligible, but insurance costs could increase.

"For every action, there's a reaction. That's certainly true in economics, Every time interest rates drop, savers are taking it on the chin," said Adrian Mastracci, investment adviser with KCM Wealth Management in Vancouver.

Savers clearly are up against it in the current interest-rate environment. The days of easy guaranteed returns are gone, unless you're willing to accept peanuts.

Consider the plight of Canadian seniors relying to a great extent on low-risk fixed-income products to sustain them in retirement. Fifteen years ago, their GICs or savings bonds might have paid 10-per-cent interest annually.

Three years ago, they might have got five to six per cent. Now, the going rate is less than 2.75 per cent, with further rate cuts possible before the end of the year.

"That's a substantial drop," said Mastracci. "I don't know anyone in retirement who can live on half what they had three years ago. It becomes a vicious circle. Retirees need income, they seek higher returns, take more risks and increase the chances of incurring losses that chip away at the retirement nestegg."

Many Canadians, even the risk-averse, migrated to mutual funds in search of better returns, only to be rewarded with two years of depressed markets that only recently started to turn around.

The mutual-fund industry still is paying for their disillusionment, with net redemptions continuing despite a recent stock-market rally. Canadians cashed out another $600 million worth of funds in June, continuing a trend that began in the spring of 2002.
Equity and money-market funds have bled the most. Conservative products such as bond, income, dividend and balanced funds actually had cash inflows.

The investors who fared best the last few years held bonds, income trusts and high-yield dividend stocks (along with real estate).

As a group, income trusts have produced compound annual returns in excess of 20 per cent over the last three years. Many have distribution rates in excess of 9 per cent a year. Small wonder they've become Canada's hottest investment product, so hot some analysts are warning they've approached the bubble stage.

"There's a place for them in a portfolio, but it's important for people to keep in mind they're not equivalent to fixed-income. They're more like equities, because there is a certain degree of risk," said John Archer.

High-profile blue-chip stocks like BCE and Trans-Canada Pipeline are an attractive alternative to GICs because their dividends (currently about four per cent a year) also get favourable tax treatment. But those returns aren't guaranteed and neither is the value of the stock.

Bonds have had a good run but still may have some upside if interest rates drop further this year, as some analysts are predicting. Archer said the most attractive part of that sector now is corporate bonds, which offer a better yield.

Floating-rate preferred shares, which have a dividend linked to the prime rate, will reward investors if interest rates change direction, as they will at some point.

In the meantime, advisers say the best defence is diversification in the asset mix and spending controls. Too big a stake in any one investment category can backfire, as tech investors know only too well. Fixed-income investments should be laddered so they don't all come to term the same year, leaving the holder vulnerable in a low-yield period like the present.

"A good portfolio is boring. It plods along," Mastracci said.

If you're not comfortable with riskier investments, try reining in your spending, postponing expenses or increasing the saving rate to help compensate for low rates of return.

And be careful not to take on too much debt, regardless of how attractive the interest rate. "If interest rates rise, and you miscalculate the carrying costs, it can be a real financial hardship," Archer said.

Mastracci sees big trouble ahead for many Canadians who have overextended themselves during the credit boom. He said inappropriate use of credit is one of the major impediments to financial progress.

"A lot of people are borrowing at very low rates, which is giving them a false sense of security. They'll be substituting today's euphoria for problems down the road. As rates go up, people are going to have cash-flow problems trying to meet payments."

NOTE: The information provided above is intended for general informational purposes only. It does not constitute advice for anyone's specific situation. Everyone should always first consult directly with their advisors to determine the appropriateness of any information contained above before taking any action. KCM Wealth Management Inc. assumes no responsibility for any loss or damage arising from the use of, or reliance upon the above information.