Article by Marcel LeBlanc for the Times & Transcript on May 9, 2019

Are guaranteed investment products really safer than risky alternatives like the stock market? Guaranteed investments have their own risks when it comes to your chances of reaching financial goals.

It’s easy to believe that guaranteeing your principal investment is the surest way to investment success but the reality is that the tradeoff for capital protection is lower average returns over time. And for many people with money to invest, low returns are the biggest threat to reaching their financial goals. Earning less on your hard-earned savings over the long term can make it almost impossible to reach big financial milestones like living a stress-free retirement or leaving an estate for your family.

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Most people avoid riskier investments because of the potential for capital losses. But the truth is that volatile investments like stock markets work in cycles. You weather the storm through the bad years in order to benefit through the good years, and historically there have been much more good years than bad years. Using data compiled from 1959 to 2018, a balanced portfolio composed of 25% Canadian stocks (S&P/TSX), 25% US stocks (S&P 500), and 50% bonds (FTSE TMX Universe Bond Index) measured in Canadian dollars would have had a 83.4% chance to have a positive rolling 12 month period, and a 95.1% chance of being positive after a rolling 3 year period. The odds even get better over longer periods with rolling 5- & 10-year periods being positive 100% of the time. Although guaranteed investments have a 100% chance of being positive or flat in the short term, their net returns over longer terms have been considerably below the average of investment options with slightly more volatility.

The problem with lower returns is that they have trouble keeping up with inflation. If your investments don’t grow more than the cost of living, your money loses purchasing power over time. Furthermore, if you’re in the stage where you’re using some investments to support expenses, your returns must also cover part of the withdrawal rate in order to preserve your capital balance.

Cash savings accounts and GICs are often portrayed as the ideal solution for investors with little to no risk tolerance. The issue is that risk is multi-faceted. When discussions around risk is limited to market volatility, it ignores another important type of risk: the risk of not reaching your goals. As an investor, what option are you more comfortable with: going through periods of negative performance with a good chance to realize the retirement you want, or obtaining guaranteed returns but lowering your retirement expectations? When market risk is the only facet of risk that is considered, investors may walk away feeling confident about the safety of their investment choice without realizing how much money was left on the table over the long term and how that may impact their goals.

Guaranteed investment products can certainly be a great tool for shorter time horizons where you need specific capital in a set amount of time in the near future. However, this doesn’t mean that this is a favorable long-term investment strategy.   

To measure the impact lower rates can have on an investment plan, let’s look at some numbers taken from simple online calculators. Let’s say someone has $1 million dollars for retirement at age 60 and plans to redeem $50,000 per year adjusted for 2.25% inflation. If they decide to avoid volatility and invests only in guaranteed investments with an assumed rate of return of 2.25%, they will run out of money at age 80 having redeemed a total of $1,245,576. Should they decide to invest in a conservative portfolio of 70% fixed income and 30% equity investments with an expected return of 4.5%, they would be able to sustain their redemption schedule until age 86 having redeemed a total of $1,740,866. That’s almost $500,000 more to spend from investing the same million dollars!   

Think of investing in riskier cyclical investments like a sailboat. You won’t sail in a straight line to your destination. The winds are unpredictable, and you must change directions to adapt for the changing conditions on the way. The ride may be uncomfortable in the worst of times but it’s a much safer option for longer distances than choosing the slow & steady option of swimming across the open sea.

Let’s face it, accumulating wealth is hard enough. If putting a portion of your wealth into slightly more volatile investments gives you a better chance of reaching your goals and requires less of your own capital to get there, it could be the safer alternative overall.