VBAL:CC - What Every Canadian Retiree Needs to Know About Rising Interest Rates
2023-12-18 10:30:00 ET
As a young investor, the rising interest rate environment of 2022 and 2023 has presented unique opportunities for me to acquire high-quality assets at discounted prices.
However, for Canadian retirees, the scenario is significantly different. Retirees typically focus on capital preservation and steady income generation rather than aggressive growth. The high volatility, spurred by rising interest rates, can be particularly disconcerting for this group.
With the Bank of Canada holding the policy interest rate at 5%, retirees need a plan that balances the need for income, the preservation of capital, and the mitigation of risks associated with a high interest rate environment.
Here’s what you need to know when it comes to investing as a retiree when interest rates are on the march upward.
Your balanced portfolio might not be so balanced
The diversified 60/40 portfolio, comprising 60% stocks and 40% bonds, has long been hailed as a balanced investment choice, particularly for older investors.
Historically, this allocation has offered a compelling blend of risk and return, providing both growth potential through stocks and stability through bonds.
However, when rates rose in 2022, the 60/40 portfolio faced significant challenges. Surprisingly, it experienced losses comparable to portfolios comprised entirely of stocks.
A key factor in this reassessment is the performance of the bond component in these portfolios. Many all-in-one investment solutions that adhere to the 60/40 model tend to include aggregate bonds with an average duration of around seven years.
Duration is a measure of a bond’s sensitivity to interest rate changes; the longer the duration, the more sensitive the bond is to rate shifts. In a rising rate environment, bonds with a duration of seven years can lose value as interest rates increase, diminishing their role as a diversifier and a stabilizer within the portfolio.
This sensitivity to interest rate hikes means that the bond portion of a 60/40 portfolio might not provide the diversification and protection against stock market volatility that investors have traditionally relied upon. As rates rise, both stocks and longer-duration bonds can decline simultaneously, reducing the effectiveness of this once-reliable asset-allocation strategy.
Case in point, the highly popular Vanguard Balanced ETF Portfolio ( TSX:VBAL ), relied upon by many retired investors, fell by 11.37% in 2022.
Cash is once again worthy of consideration
In an era where the Bank of Canada’s interest rates stand at 5%, cash and its equivalents are reclaiming their significance in investment portfolios, especially for retirees. This shift marks a departure from the previous norm, where savings accounts yielded a paltry 0.5% APY.
Today, these virtually risk-free cash alternatives are offering competitive yields, making them an attractive component in a diversified portfolio. For retirees adhering to a traditional 60/40 portfolio, the integration of a cash allocation can be particularly beneficial.
Cash reserves provide enhanced liquidity, which is essential for retirees with regular cash flow needs. This immediate accessibility ensures they can meet their expenses without the need to liquidate other investments, especially during market downturns.
Moreover, cash serves as a stabilizing factor in a portfolio. Given its nature, it can help mitigate overall portfolio volatility , offering a buffer against the fluctuations of stock and bond markets. This stability is crucial for retirees who often prioritize capital preservation and steady income.
For a cash holding, consider Purpose High Interest Savings Fund ( TSX:PSA ). This unique ETF is designed to remain relatively stable in price and payout monthly interest at an annual net (after fees) yield of 5.17% as of December 6, 2023.
The post What Every Canadian Retiree Needs to Know About Rising Interest Rates appeared first on The Motley Fool Canada .
Fool contributor Tony Dong has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy .
2023