Fixed income is often used to describe a category of investments that provide investors with income that one purchases to receive income.
Some examples of fixed-income investments include Canada savings bonds, Canada premium bonds, government bonds, treasury bills and corporate bonds. These types of fixed-income investments generate income payments that the purchaser would know in advance. Yield is a term that many people refer to when discussing income. Yield is always expressed as a percentage and is essentially the annual expected income divided by the current price of the fixed-income security.
When you are working and saving into your investment account, the primary objective may be to obtain growth. In retirement, the goals have traditionally shifted to a need for income and capital preservation. Historically, one would look primarily at fixed income for both income and capital preservation.
Since the early 1980’s, most yields on fixed income investments have significantly declined. In October 2017, the Government of Canada made the decision to no longer issue new Canada Savings Bonds (CSBs) or Canada Premium Bonds (CPB). The current yield on a Government of Canada ten-year bond was 1.28 per cent (information per Thomson One as of August 22, 2019). The yield on a basket of investment grade bonds held in the iShares Canadian Corporate Bond Index is 2.91 per cent (information per Thomson One as of August 22, 2019).
Historic financial textbooks would also discuss fixed income as being lower risk than equities. The challenge with this statement is that it paints both of these asset classes into two broad categories. Not all fixed income is low risk and not all equities are high risk. Rating agencies such as Moody’s, Dominion Bond Rating Service, and Standard & Poor’s rate the credit quality of fixed income investments. Essentially they provide a rating on the likelihood of you receiving your income payments and capital upon maturity. Some fixed-income investments can be very risky. Some fixed-income can have currency risk if fixed income is not all within Canada. The biggest risk with fixed income is that the current yield doesn’t even keep pace with inflation. This is particularly concerning when people are living longer in retirement.
Most of Canada’s biggest companies have been in existence for more than a century. Nearly all of these large companies have a long history of paying dividends and increasing payments over time. Below is a list of the 10 largest companies, by market capitalization in Canada, along with the approximate age, ticker symbol and current yield on the common shares (information per Thomson One as of August 22, 2019 market close). All of the equities in the table below for example would be considered medium risk.
|Royal Bank of Canada||155||RY||
|Canadian National Railway Co.||100||CNR||
|Bank of Nova Scotia||187||BNS||
|Brookfield Asset Management Inc.||120||BAM.A||
|Bank of Montreal||202||BMO||
|Suncor Energy Inc||102||SU||
Yields from Thomson One as of Aug. 22, 2019
The average yield on the 10 securities listed above is 4.2 per cent, which is considerably higher than the yield on both government and corporate fixed income. One of the added benefits of purchasing common shares is the potential to also get share price appreciation. Of course, the concern some people would express with common shares is also the potential for the share price to decline.
My advice for investors wishing to increase equity exposure is to focus on quality equity investments and avoid speculative positions.
Below are some interesting statistics for someone taking a more extreme look at abandoning fixed income all together and having an all equity portfolio:
• Calendar-year returns for an all equity portfolio were positive 42 times out of 59 occurrences. 71 per cent of the time, an all equity portfolio had positive returns between 1960 and 2018 (based on the calendar year returns of the S&P / TSX Composite Index from the period 1960 to 2018).
• Three-year annualized returns for an all-equity portfolio were positive 51 times out of 59 occurrences (or 86 per cent of the time) for the period between 1960 and 2018 (based on three year annualized returns of the S&P / TSX Composite Index from the period 1960 to 2018).
• Five-year annualized returns for an all equity portfolio were positive 57 times out of 58 occurrences (or 98 per cent of the time) for the period between 1961 and 2018 (based on five year annualized returns of the S&P / TSX Composite Index from the period 1961 to 2018).
It may seem contrary to many older text books, but one way to increase the yield in your portfolio is to decrease fixed income and increase equities. I wrote an article on April 12, 2019 that outlines how asset mix should be tied to cash-flow needs and market conditions. Individuals looking to increase the equity component of the portfolio should always set aside funds for short term cash flow needs.
Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the Times Colonist. Call 250-389-2138.