Your investment horizon should play a large role in determining how you invest your money across different ‘asset classes’, or types of investments.
The longer your investment horizon, the more you should invest in high-quality, dividend-paying stocks. For shorter time horizons, the more you should invest in fixed-income investments such as bonds or GICs (Guaranteed Investment Certificates).
You likely have a long investment horizon with regards to your RRSP (Registered Retirement Savings Plan). For one thing, many high-quality companies pay dividends that yield significantly more than government bonds. That’s why stocks appeal even to income-seeking investors.
For another thing, you or your spouse can inherit the RRSP from each other tax free. This means that it can be invested for longer than the contributor’s life expectancy.
Some investors worry about losing money in a stock market setback. Particularly given the upswing of stock prices in recent years. Some feel that the stock market is ill suited to RRSPs. But while stocks are riskier than fixed-income investments in the short run, stocks are safer over the long run.
Stocks win over long run
Data from 1802 to 2012 shows that stocks delivered inflation-adjusted returns of nearly 67 per cent in their best year. They also lost close to 39 per cent in their worst year. Bond returns were more stable. In their best year, bonds returned over 36 per cent. They lost nearly 22 per cent in their worst year. But as you extend the investment horizon, stocks keep doing better and better.
Over all 10-year holding periods, stocks beat bonds. In their best 10-year holding period, stocks earned annual compound returns of 16.9 per cent. In their best 10-year holding period, bonds earned annual compound returns of 12.4 per cent.
In their worst 10-year holding period, stocks had annual compound losses of 4.1 per cent. In their worst 10-year holding period, bonds suffered annual compound losses of 5.4 per cent. Over all periods of 10 years or more, stocks did better.
Diversify with an ETF
Based on this evidence, when holding for 10 years or more, you should invest in stocks. Just make sure that your portfolio is well-diversified to eliminate what’s known as idiosyncratic risk or company-specific risk. You can diversify away this risk by investing in a broadly-diversified ETF (Exchange-Traded Fund).
When it comes to shorter investment horizons, you should stick to fixed-income investments that can at least retain their value. Otherwise, in a stock market setback you may no longer have a down payment on a house. You may have to tell your children or grandchildren that the planned trip to Disneyland is off the table. Your university-bound children or grandchildren may have to learn about the joys of eating Kraft dinner and racking up student debt.
This is an edited version of an article that was originally published for subscribers in the June 11, 2021 issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.
The Investment Reporter, MPL Communications Inc.
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