Investment Policy

Each little box represents one aspect of my core business, which is to develop a financial plan that will give my clients the best possible opportunity to realize their most cherished dreams - to the extent that those dreams can be realized with money.

I then encourage clients to stay with the plan, through good times and bad. The Bear Market of 2008 indicated how hard that can be!

Chart 1 indicates what a broadly diversified portfolio might look like. Everyone has unique needs, so I will vary the weightings of each asset class in accordance with the individual's time horizon and personality.

We estimate that the portfolio shown in Chart 1 will have a future return of 7.9%, with an annual standard deviation of 8.6%. At the 99^th percentile confidence level (the "once in 100 years" disaster), the worst return from this portfolio is likely to be -14.1%. The 2000-2002 Grizzly Bear Market was a 99^th percentile event. Unfortunately, the 2008 Bear was even worse at -19.6%.

Chart 1

Guaranteed Retirement Income Portfolios

...a GRIP is useful to fill the income gap between guaranteed pension income and necessary expenses like food and shelter.

At the risk of oversimplification, during the accumulation phase the notional value of a GRIP rises by 5% simple interest every year. Every 3 years, the guaranteed value gets reset to the higher of market value of the underlying investments or the notional value.

During the withdrawal phase, retirement income is set at 5% of the guaranteed value for life. Every 3 years, the guaranteed value gets reset to the higher of market value of the underlying investments or the original guaranteed value. If markets have been strong so that the increase in market value has exceeded the withdrawals, the guaranteed value will get reset upwards, and withdrawals will be based upon this new guaranteed value.

The GRIP is suitable for someone who is pessimistic about the market's ability to produce at least a 5% return over the time of their retirement, but doesn't want to be left out if the market happens to do better. (The pessimistic pessimist should buy an annuity!)

I like the idea of using a GRIP to fill the income gap between CPP, OAS and any other guaranteed pension income, and necessary expenses like food and shelter. With the necessities of life covered off by a guaranteed lifetime income, it becomes possible to use other savings for the things that make retirement more enjoyable.

The 2009 RRSP contribution limit is $21,000. The limit for 2010 will be $22,000.

RRSP Loan

Even if you have the cash burning a hole in your back pocket, it may make sense to consider an RRSP loan. My various loan providers are back to competing for your business, and - WOW! - are they offering good deals! Our traditional supplier of RRSP loans is offering 1 or 2 year loans at 4%. However, the lender that I use for investment loans has come into the RRSP marketplace with an unbeatable offer of Prime+0.5%, or 2.75%.

This loan offer has no maximum limit (minimum is $2500) and the usual terms of fully open for prepayment and deferral for up to 180 days. It's a great way to catch up on all that unused RRSP contribution room because an RRSP loan will give you a government-guaranteed 48% return on your investment. Here's the math: Suppose you take out a $6,000 RRSP loan in February, with the proceeds placed into a money market fund so that there is no market risk. If you're in the 33% tax bracket, this will give you a $2,000 tax refund, which you'll use to pay down the loan principal.

You have chosen a 1-year amortization of the loan, and have deferred payments for 90 days. By that time you'll have received your tax refund and paid down the loan, so the outstanding principal is only $4,000. You make 8 monthly payments of $507.48 and you've retired the loan in time for the following February.

Your invested amount is $6,000; your out-of-pocket cost (including interest) is $4,059.84. The return on invested capital is a cool 48% - government-guaranteed!

You can scale the numbers I've used in this example up or down to meet your personal circumstances, but you'll always get that 48% return. Keep this in mind this RRSP season!

Our favourite supplier is offering RRSP loans at Prime + 0.5%
That's only 2.75% right now!

Do You Prefer DCAF?

Wouldn't it be nice if there were some way of participating so that you can dip your toes slowly into the market? Happily, there is!

One of my favourite fund companies offers their full suite of mutual funds in a DCAF version. That's short for Dollar Cost Averaging Fund. Dynamic Mutual Funds will place your RRSP contribution into a money market fund. Then, every Monday, they will automatically transfer 1/52 of the account balance over to the equity or balanced fund of your choice.

This is a great way to ease your way back into the stock market over the next year. Dynamic's DCAF is also eligible for the loan program that I discussed in the previous section!

Tax Free Savings Accounts

As an added bonus, unused TFSA contribution room accumulates, just like unused RRSP contribution room.

You can put all manner of investment into a TFSA. There are two extremes:

• The banks are pushing the idea that TFSAs should be used as a low-interest savings account. This is appropriate if you plan to withdraw the money in short order for another purpose, but it is not suitable for longer-term savings.
  
  
• At the other extreme, some investors have chosen to use their TFSA as the place in which to purchase their most risky speculations, for example junior mining or oil stocks. The idea is that if they have a 10-bagger, the gain will all be tax-free.

My clients have tended to use a somewhat more conservative strategy. We have invested in income-producing mutual funds.

Each month, we take the distribution and place it in a money market fund. This strategy separates the "income" component from the "growth" component of the mutual fund.

Table 3
2009 Returns to 31 December

MSCI: Morgan Stanley - Capital International
EAFE: Europe, Australia & Far East
Globe: Globe & Mail

Where We Are

Interest rates remain steady at very low levels. In fact, Canadian bond rates continue on a slow decline that has been in place since mid-2007. If there is inflation on the horizon, the bond market is not showing any concern.

Most clients have balanced portfolios. I use the Globe Canadian Neutral Balanced Peer Index as my primary performance benchmark. This index was up 16.9% on the year.

Within sectors, Precious Metals was the star, up 60.7% even though gold itself only rose 6.9%. More broad-based Natural Resources funds were close behind, up on average 58.4%. Emerging Markets was next, up a mere 56.3% on the year.

Technology broke out of its decade-long slump by posting a 36.4% return. Financial Services, at 31.4% and Real Estate, up 22.6%, did quite well. Health Care lagged the field, up only 12.5% on the year.

Where We're Heading

CAD/USD = 0.005 * (oil price) + 0.56

Parity will occur when (or if) WTI oil reaches $88/bbl.

Economy
It seems quite clear that the world is slowly emerging from its funk. Chart 2 shows that world trade is gradually recovering.

Chart 2

Chart 3

Chart 4

I've noted before that the stock market has only a tenuous relationship to the economy. More important are "conditions": things like interest rates, monetary conditions and the potential for increased earnings.

Right now, conditions are extremely favourable. While the economy is growing again, it is recovering very slowly. The bond market is screaming that inflation is not even on the horizon. Governments are talking about reducing the amount of their stimulus, but deficit spending continues.

There's an old saying: "Don't fight the Fed." The Federal Reserve Bank in the US is telling us loud and clear that conditions will remain bullish for quite some time.

We can assume that at some point in the future the stimulus taps will be turned off, and interest rates will rise. The merry-go-round will stop. At that point, but only then, will conditions turn bearish. In the meantime, we should enjoy the ride.

The Black Cloud
And yet, out there...
"True, governments can reduce the rate of interest in the short run. They can issue additional paper money. They can open the way to credit expansion by the banks. They can thus create an artificial boom and the appearance of prosperity. But such a boom is bound to collapse soon or late and to bring about a depression."

Winter Scene - Columbia Valley