A retirement gamble

RRSP money is flooding into the stock market

BRENDA DALGLISH February 14 1994

A retirement gamble

RRSP money is flooding into the stock market

BRENDA DALGLISH February 14 1994

A retirement gamble


RRSP money is flooding into the stock market


The latest fashion at the country’s largest discount brokerage is the over-the-shoulder tie. With calls flooding into Green Line Investor Services at record levels, brokers are flipping their expensive silk ties back to keep them out of harm’s way as they frantically record telephone orders on their computer keyboards. In Green Line’s two Toronto trading rooms, brokers have been answering 20,000 telephone calls a day since the beginning of the year as investors charge into a superheated stock market. Richard Wilks, Green Line’s Toronto branch manager, says that the first two months of the year are always busy because of the March 1 deadline for contributions to registered retirement savings plans (RRSPs), but even by those standards this year has been extraordinary. Said Wilks: “The retail investor is back, full blast.”

For Canadians who are trying to decide where to put their RRSP contributions this year, the stock market appears both enticing and frightening. Low interest rates are repelling investors from the traditionally popular low-risk guaranteed investment certifi-

cates (GICs), which as recently as 1990 were capturing three-quarters of annual RRSP contributions. Comparable figures for this year are not available, but at Green line, roughly 70 per cent of GIC money coming up for renewal is flowing into mutual funds.

At the same time, the surging stock "

market is singing its siren song. Bearing out investment veterans’ warnings that the stock market was flashing danger signals, the Toronto Stock Exchange’s index of 300 companies, a barometer of its performance, dropped 113 points last Friday to close at 4,447 points. But it had already gained 300 points this year, after moving up almost 1,000 points in 1993. Similar tailspins occurred on stock markets throughout North America on Friday, after the U.S. Federal Reserve Bank pushed up the short-term federal fund rate by 25 basis points to 3.25 per cent. The higher interest rates also knocked down the value of two other popular investments that


have been replacing GICs as favorites of conservative investors—bond and mortgage mutual funds. Although inexperienced investors may not realize it, those types of mutual fund investments, which are not protected by the Canada Deposit Insurance Corp., lose value when interest rates rise.

The sudden, sobering upturn in interest rates will make the investment decisions of RRSP contributors even more complicated this year. Regardless of the uncertainties, however, investors are setting aside record amounts of RRSP savings, and their favorite RRSP vehicle is mutual funds. Pooling individual investors’ money, mutual funds invest in a diversified group of securities that include varying mixes of common shares, bonds, mortgages, money market investments, preferred shares, foreign stocks and bonds and even ' í gold and real estate. Mutual funds are not exclusively linked to RRSPs, but the investment industry estimates that most mutual fund investments are held in such retirement programs. Last year, investors spent an incredible $35 billion—the equivalent of almost $1,300 for every Canadian— buying new units in the country’s 630 registered funds. And mutual fund managers say that, although firm numbers are not yet available for January, sales are still growing.

And while money pours into mutual funds, an increasing portion of those funds is being invested abroad. Last year, $7.4 billion went into funds investing in the common shares of Canadian companies, up from $2 billion in the previous year, while another $7.7 billion went into foreign share funds. That was up from $1.9 billion in 1992, and was the first time that Canadians bought significantly more shares in foreign companies than they did in Canadian ones. Peter O’Sullivan, an RRSP adviser with Phillips Hager &

North in Vancouver, cites two reasons for the popularity of foreign investments. One is a change in RRSP rules in 1990 that increased the permissible level of foreign investments. As well, investors are taking advantage of the higher limits as a way to shelter some of their savings from risks associated with Canada’s overall economic performance.

In general, most investment advisers applaud Canadians’ new willingness to invest in stocks, because historically the stock market has outperformed all other types of investments over the long term. But they also say that risk-averse investors, particularly those who are nearing retirement and would

Pumping up tiie market

With low interest rates severely diminishing the earning power of traditional low-risk investments, fund managers are diverting retirement savings into more volatile holdings that offer a much bigger potential for return.

Earnings available with almost no risk:

6-month treasury bills 5-year guaranteed investment certificates

While other investments come with no guarantees, they may boast impressive track records. Last year’s average earnings:








Money market funds

Mortgage funds

Canadian bond funds

Balanced funds(stocks mixed with fixed-income securities)

Canadian Equity funds

International Equity funds

Sector funds and precious metal funds

suffer if the stock market went into a lengthy decline, should not shun GICs merely because interest rates have fallen. Indeed, Gordon Pape, a personal finance analyst, says that people often focus on the raw rate of return rather than the real after-inflation rate. With inflation now down to two per cent from six per cent four years ago, a return of five per cent now is equivalent to the nine-percent rates available then.

The investors most hurt by low interest are retired people who are living off the returns from their investments, notes Toronto chartered accountant Jim Todd, a personal finan-

cial planner. “In the short term, they go from getting 10 or 12 per cent on their investments to getting five or six per cent,” he said. “It’s like having their incomes cut in half.” But especially for people in their prime working years between the ages of 30 and 60, the low inflation that brings interests rates down can be helpful because of its positive effect on the economy. “The stock market will do well because companies will be able to borrow at low rates and grow,” said Todd. If it continues for an extended period, low inflation also greatly reduces the amount of savings that people need for their retirement Despite that optimistic scenario, which is shared by many investment advisers, there are several dangers that investors need to be aware of HfÜll now. Most immediately, there is the question of whether the rise in U.S. interest rates will merely cause the stock market to stall briefly or depress it for an extended period. Says Robert Krembil, an investment manager at Trimark mutual funds in Toronto: “You can’t have a longterm rally without a correction or two.” Ron Meisels, a stock analyst in Montreal, agrees. “It wouldn’t hurt if the market came back down 200 points or so,” he says. “But it would just be a correction. I’m not saying that this market is ready to collapse.” For his part, Stephen Jarislowsky, a leading Montreal-based investment manager, says that the mood of many investors worries him. Greed, he says, is gaining the upper hand among some, who have come to expect annual returns from their stock investments of 20 or 30 per cent. “Someone is going to pay,” he warns. “They always do.”

But the temptations are strong. The Toronto stock market returned an average of 33 per cent to investors last year, the best single year on the markets since 1983. Those gains came even though corporate profits remained low. Some analysts say that the rapid gain in many companies’ share prices has raced too far ahead of their ability to return profits. Shares on the Toronto Stock Exchange are now selling for an average of 120 times their earnings, compared with a more traditionally acceptable level of about 20 times earnings. For the moment, that aberration is being balanced by the wave of money shifting into stocks because of low interest rates, and by a flood of retirement savings coming from the baby boom generation. So long as that money keeps flooding into the market, it will put upward pressure on almost all share prices. But once it begins to slow, individual stocks will likely become more volatile, as investors shift

their money around from one to another.

Another fundamental reason for fear about the stock market is the danger that last week’s upturn in U.S. interest rates will be the beginning of a significant rise in Canadian rates. If that were to continue, some investors would be inclined to move out of the stock market back to more conservative interestbearing investments. Interest rates have been falling in Canada since 1990, and with the economy remaining weak the Bank of Canada has had no cause to increase them to head off a rise in inflation. But with the economy gathering strength in the United States, Federal Reserve chairman Alan Greenspan acted last week, with the effect that, in Canada, shortterm interest rates also edged up slightly.

A rise in interest rates is also bad news for two other kinds of investments that have become popular recently. Canadians have $17 billion invested in bond mutual funds and $5.3 billion in mortgage funds. But the principal values of bonds and mortgages fluctuate in inverse relationship to interest rates, meaning that higher interest rates would push down the value of those funds’ units. For unsophisticated investors more accustomed to GICs, which cannot lose value and are covered by CDIC insurance provisions, a sudden reduction in the value of their holdings would come as a rude surprise. And some fund managers are not helping investors prepare for that possibility. O’Sullivan, for one, is critical of current advertisements that feature bond and mortgage funds’ past performances. On average, bond funds returned more than 14 per cent last year, but that was partly due to a decline in interest rates that pushed up the value of bonds and mortgage funds. O’Sullivan calls it misleading advertising when funds leave the impression with inexperienced investors that similar rates of return might be possible in the coming year. “There is very little chance of that, because interest rates just don’t have much more room to fall,” he said. “I’d be very wary of any group that was heavily promoting its bond and mortgage returns this year.”

Meanwhile, brokers are dealing with a new, and potentially risky, approach to mutual fund trading. The investment industry, led by the discount brokers, has made trading the funds so easy and inexpensive that many investors are trading funds back and forth the way speculators might play penny stocks on the Vancouver Stock Exchange. “The whole style of investing has changed,” said Green line’s Wilks. “But mutual funds, which are intended to be long-term investments, aren’t set up for that.” By trading them and trying to outsmart the market, investors greatly increase their risk. In the last year, some funds have even set up penalty systems to discourage investors from trading into and out of their funds more than a few times each year. Says Wilks: “The trouble is that trading is addictive. It’s fun.” And when the market rages, more and more Canadians get hooked.