Fixed income is not the fix for anxiety

Security and predictability are a great source of emotional comfort when the markets seem erratic and volatile. But how much security and predictability are too much? And what’s the price for short-term comfort?

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Security and predictability are a great source of emotional comfort when the markets seem erratic and volatile. But how much security and predictability are too much? And what’s the price for short-term comfort?

Many Canadian investors are sharing the sentiment that the ups and downs of the markets are stressful. This is motivating them to think about moving money to less-risky, and more predictable, fixed-income investments. The logic is sound; any port in a storm, as they say. But not all fixed-income investments are equal. And the ones you choose should be a reflection of your age, your goals, and your overall tolerance for risk, not a reaction to the markets.  

Imagine how you might feel if you had one million dollars in 1996 and by 2019 it was only worth $375,413. That’s what’s at stake when you ignore inflation.

What’s at stake?

A well-balanced investment portfolio will have a combination of equity and fixed-income investments based on your age, tolerance for risk, and the goals identified in your IG Living Plan. Generally, portfolios shift to a greater percentage of fixed income investments the older you get to reflect less appetite for risk. But if the mix of equity and fixed-income investments in your portfolio gets reset because of anxiety or uncertainty, your long-term success can come under attack from inflation and lost opportunity.

1.     Inflation

Consider the chart below. Over 24 years, with even a modest rate of inflation (just 2%), the purchasing power of one million dollars drops by almost 40%. At 4% inflation, that increases to over 60%. So, keeping pace with inflation ought to be your minimum investment goal because your investments could actually go down in value relative to the cost good and services.  

Imagine how you might feel if you had one million dollars in 1996 and by 2019 it was only worth $375,413. That’s what’s at stake when you ignore inflation.

2.     Opportunity cost

Opportunity cost is the amount of additional money you could have made by choosing one financial decision over another. In the case of fixed-income investments, the lost opportunity is the money you might have earned had you invested your money differently. For example, compare these two investment returns over a 5-year period ending September 30, 2019.

In this example, an investor who accepted a slightly higher risk level (S&P TSX Composite) was rewarded with an additional 1.42% compound annual growth and that added up to a difference of 8.4% just five years later. For risk averse investors, fixed income diversification may be a wise compromise.

A better approach: diversification

One way to address your need for greater security without risking your money to the cost of inflation and lost opportunity is to re-evaluate the combination of fixed-income investments in your portfolio. It can be more effective to invest in a mix of actively managed assets that deliver risk-adjusted returns such as bonds, mortgages, and cash.

The chart below shows you there is a wide variety of fixed-income investments to choose from and the top-performers vary from year to year. This is why it can be more effective to diversify your investment throughout the range of options and benefit from the combined average rate of return over time. 

This chart shows the relative performance of fixed-income investment types from 2014 - 2019. Performance is ranked top to bottom in each year.
So, if the ups and downs of the market have you feeling unsettled, talk to an IG Consultant about all the ways you can achieve greater fixed-income diversification within your current plan.