In this next segment of the Pension Advice Series, let’s look into the details behind Guaranteed Fixed Income Investments. After having looked at 5 Considerations When Building a Laddered Fixed Income Portfolio, the next logical question to answer was with regards to the guarantees offered by some investments. As discussed last time out, there are many products that can be used to fulfill your fixed income needs.

These include non-guaranteed investments; ETFs, mutual funds, debentures, banker assurance notes, commercial paper and preferred shares as well as those with a notion of guarantee; term deposits (certificates of deposit and guaranteed investment certificates), bonds and treasury bills. Let’s look at these last three in greater detail.

Treasury Bills.

Treasury bills are issued by Federal Governments and are generally hold the highest rating in terms of safety against default and have terms to maturity of less than one year. So the safety of the guarantee is related to how solid the issuing government is in the ability to pay back their debt. Stay away from the PIGS (Portugal, Ireland, Greece and Spain) if you are looking for guaranteed investments.

These are rarely held in individual portfolios of less than a million dollars as there are other ‘safe’ products that pay higher interest rates and therefore are less affected by transaction costs. Often used as the basis for money market mutual funds, as well as the cash portion of institutional portfolios and pension funds. So if you are looking for an investment in “near-cash”, treasury bills are the benchmark to measure against. If you see another investment, such as asset-backed commercial paper boasting the same AAA rating yet offering twice the yield of t-bills, remember the fiasco that touched off the most recent stock market meltdown before you make your purchase.

Term Deposits.

The next segment to look at are term deposits which are also referred to as certificates of deposit and guaranteed investment certificates, depending on where you live and where you look. The concept is rather simple. You deposit your hard-earned cash in a financial institution for a certain amount of time (term) in return for their promise to pay you a guaranteed rate of interest and the return of your capital. The guarantee offered is as good as the strength of the financial institution and the government agency that regulates the deposit insurance, if available.

In the USA, the Federal Deposit Insurance Corporation (FDIC) guarantees the safety of deposits in member banks, up to $250,000 per depositor per bank. In Canada, the Canadian Deposit Insurance Corporation (CDIC) works in a similar manner up to $100,000 per depositor per financial institution for deposits up to 5 years in length. In general, the higher the amount invested, the higher your rate. Again if security is really important, be sure to understand the rules regarding federal deposit insurance.

Bonds.

As touched upon last week in an article I wrote a while ago, Create a Fixed Income, Don’t Confuse Return with Revenue, you will need to be even more careful when buying bonds. First of all, not all bonds are alike. The safety of a bonds guarantee is based on the financial strength of the issuer. In general, federal government bonds are safer than state/provincial and municipal issues (PIGS notwithstanding). More often than not, government bonds are safer than corporate issues.

Now let’s see how a bond works, the issuer has created a security (always read the prospectus before buying) that states the rate of interest is paid, the frequency of payments (annually or semi-annually) and the maturity date (when the capital borrowed is returned).

So, in other words, an investor lends the issuer their hard-earned cash for a set period of time and is paid rent in the meantime. This is done as the issuer can normally pay less interest than if they are borrowing from a financial institution (as the risk is diversified over many lenders). As an investor, the return on your investment (yield) and capital are only guaranteed if you hold the security until maturity and if the issuer does not default. So stay away from companies, municipalities, even states (ex. California) who are not financially sound. You should be concerned with the long-term financial viability of the issuer because it is the maturity date that counts if you want your capital back, just ask Germany about their Greek debt!

We hope that this information about guaranteed fixed income investments has helped clear up any lingering questions about the subject. Next time out, we’ll diversify the portfolio beyond fixed income by adding a growth segment and look at different approaches using Asset Allocation. Does your portfolio include guaranteed fixed income investments? If not, where are you invested?

Author: Robert

Asset allocation has been proven as a key to efficiently maximizing your investment returns and will always generate a number of questions. Today, we will strive to provide answers to those who question how to make sense of your asset allocation when a significant amount of your savings is tied up in a pension plan. So after reviewing Amy’s Results: Generate Income From Your Own Pension Plan and discussing fixed income products in depth, we turn our attention to diversifying a portfolio by adding a growth segment to the mix.

We will concentrate on how to incorporate growth investments into the picture and as such, you will find it helpful to look back at 6 Considerations of Where to Invest Your Retirement Savings. We’ll divide our attention based upon whether or not you are fortunate enough to work where they provide a company pension plan.

Company Pension Plan: Defined Benefits.

While we have already addressed the importance of choosing Your Ideal Asset Allocation, let’s look at how your company’s pension plan fits into your overall portfolio. If you are among the few left with a defined benefit pension plan, you are quite fortunate. Many businesses (and soon governments too, perhaps) have started to move away from offering these types of plans. Here is why: a defined benefit pension plan is a fixed income offering.

So, in terms of your asset allocation, the cash transfer value of your company pension plan should be used in its entirety when calculating the dollars you have allocated to fixed income. Employers are shying away from defined benefit plans as safe investments have historically low returns and growth investments in the stock markets have been drubbed on an increasing rapid rate. So rather than be responsible for benefits, employers are changing to defined contribution plans to reduce their risks. Remember, a defined benefit pension plan is 100% fixed income.

Company-Sponsored Defined Contribution Pension Plan.

If you are like the rest of us and have a defined contribution company pension plan, you probably have a list of investments to choose from. My suggestion is pick the investment with the best track record (use an independent firm like Morningstar to judge) and the lowest fees. More often than not, the trust company or insurance firm who manages the account on behalf of your employer charges their fees on top of those within the mutual funds/segregated funds. Often these fees go up when the amount of growth inside the fund rises, for no explicable reason. It’s like like their fiduciary costs climb based on the risk inside the fund!

Anyways, you are better off with a balanced or dividend income fund if the fees are lower and the fund has a solid track record. In this way, you can likely just pick one or two funds for the contributions. Use the funds asset allocation to determine what percentage of your assets are allocated to fixed income versus growth. Send us your comments if you have questions on the choices available to you.

Self-Directed Retirement Savings Plan.

If you have total reign over how to invest your retirement savings, then the choices available to you are virtually unlimited. If you haven’t already done so, take a look at the 7 Ways to Invest Your Retirement Savings that covers the range of options open to you. You will want to start off by understanding your investor profile. This will help you understand your comfort level with risky assets and depending on where you invest, guidelines will be suggested to help you determine the percentage of your savings dedicated to growth and fixed income products.

These days, you might want to consider Guaranteed Fixed Income Investments to go along with your growth investments. As interest rates rise in the coming years (we hope), any fixed income ETFs and mutual funds will likely drop in value, or at best tread water. So don’t be greedy, just try to beat inflation for the next two to three years in the fixed income component. The remainder of your portfolio can concentrate on growing your nest egg for retirement.

Enough said for today, we’ll look at how your age and the number of years until retirement affects your Asset Allocation and Pension Plan choices.

Author: Robert

(photo credit: bluecowboy2002)

We will continue to build upon the retirement income train of thought after recently discussing How to Generate Income From Your Retirement Investments. There are five considerations when building a laddered fixed income portfolio. As opposed to much of the information available out there, we are not here to sell you anything.

Therefore, we will walk you through the strategy of a laddered approach, the different products to choose from when creating a ladder, and their differences when it comes to flexibility. We’ll also address how to choose the term to maturity and the the importance of considering where we are in the economic cycle.

What’s the strategy?

As touched upon last week when we looked at Amy’s Results and How to Generate Income From Your Own Pension Plan, a laddered approach to the fixed income portion of your retirement is often recommended. The priorities for most people on a retirement income are three fold: to have guaranteed investments (both the capital invested and the yield), to get the highest interest rates possible and to have a stable income. While this is totally understandable, you should realize that these objectives are polar opposites.

This being said, a laddered approached can help you maximize yield while respecting the need for guarantees and income stability. A basic ladder is having 20% of the fixed income mature every year over the next five years. If your income needs change during the year you can adjust at the next maturity. If not, reinvest the capital for another five years, usually the highest rate (while ensuring Canadian deposit insurance coverage).

Products?

As discussed earlier, you are looking for investments that guarantee your capital and the yield. This narrows the choices available for your portfolio. Fixed income means that the amount of income generated by the product is fixed ahead of time.

Another important aspect of a product: who is guaranteeing the capital and return. It may also be helpful to review an article I wrote a while ago, Create a Fixed Income, Don’t Confuse Return with Revenue. The different products available are: term deposits (certificates of deposit and guaranteed investment certificates), bonds and treasury bills. You will notice I have not included ETFs, mutual funds nor preferred shares as we are looking for guaranteed capital and yield.

Flexibility?

It is important to determine your need for flexibility. I should stress the word: Need. Everyone wants flexibility. If you insist on it, you will reduce your return. Term deposits can be cashable/redeemable prior to their maturity dates. Often the rates are significantly lower (50% less at times) than certificates of deposit and guaranteed investment certificates that are not redeemable before the maturity date. On the other hand, treasury bills and bonds can be sold in a secondary market before the maturity date (see The Economic Cycle below for other risks involved).

Term to Maturity?

The number of maturity dates depends on the amount of your portfolio invested in fixed income products. This is because smaller investments have lower returns due to rates and commissions paid for bonds and t-bills. I have met numerous clients who would prefer to have 12-24 maturities, one every month for the year or two. As was the case for flexibility, few people really need this. Often, dividing your nest egg into five to ten portions makes sense. With investments of $50000 or more, it is possible to get bonified rates and commissions on bonds can be negotiated. If you have more than a million, look at bond terms over 5 years, after rates have gone back up (we are still looking at some of the lowest interest rates in history).

The Economic Cycle.

We have saved the most important news for last. Your ability to maximize the return/yield/interest rate is greatly affected by the economic cycle. It used to be a local thing but lately has been more affected by global events. So when you ask your advisor to find you a 5% term deposits and he answers with a nine year term to maturity, don’t be insulted. Thank the most recent bad news from around the planet. From the natural disasters in Japan, to the Greek sovereign debt or the unemployment closer to home in the USA, bad news creates a flight to safety. When more investors buy bonds, the price goes up.

As the prices go up, the yield goes down. Then to add insult to injury, once you have bought bonds, if the interest rates rise, the market value of your portfolio decreases. So, the lesson to remember, if rates are likely to rise (and remember: we are still looking at some of the lowest interest rates in history), be sure to hold your bonds to maturity. Yes, we said that bonds can be sold in a secondary market before the maturity date and the risk is they could be sold at a loss.

Next time out, we’ll look into the guarantee aspect of fixed income products. Let us know how you structure your fixed income ladder.

Author: Robert