Retirement Plan

The next most important rule in achieving high retirement savings is to use a sound strategy. A sound strategy does not necessarily mean the safest strategy. Rather, a sound strategy is one which goes further, taking on a moderate amount of risk, in order to boost the average annual return over time. Consider someone starting with $100,000. After 30 years, the value of the portfolio, compounded at 5%, would be $444,671. If, instead, the portfolio compounded at 8%, the value would be $1,052,470. This is an enormous difference and would probably mean a lot to a retired person's comfort level and enjoyment of life. This illustrates why it is important to work hard to produce the extra 2 or 3 percentage points of average annual return.

The safest route in investing is to hold government treasury bills and short-term government bonds. Currently, this would give a return of no more than 5% per year. This provides for the almost certain return of money invested, plus interest. However, there is an important shortcoming to this approach for those seeking to maximize return over time. Historically, stock markets have produced a higher average rate of return than treasury bill or bond investments when measured over periods of several decades. For the period 1954 to 1995 in Canada (prior to the recent run-up in the stock market) average returns were as follows: T-bills 6.6%; Long bonds 6.6%; stocks 10.5%. (U.S. historical figures are similar).

Certainly, there is a higher risk associated with owning stocks, and the returns cited are for the broad stock market as a whole (not individual company stocks which may have done better or worse). In addition, there is greater volatility of returns year by year for stocks compared to the others, although over 10 year periods since the 1950s, stocks have shown positive returns. Will history repeat itself? That is, will a properly diversified stock portfolio continue to outperform T-bills and bonds? There are no guarantees. However, with history on their side, investors with at least 5 to 10 years until retirement, should consider some stock ownership in their portfolios. Perhaps, with a portfolio half in stocks and half in bonds, they would be able to achieve something closer to 8% on average than 5% over a period of a decade or more.

Various studies of historical data have concluded that portfolios that are diversified into different types of assets, such as bonds, T-bills, and domestic and foreign stocks, provide the best return and lowest risk over time. Indeed, in recent years, foreign stock markets have far outperformed the Canadian stock market (mainly due to the greater weighting of resource stocks in the Canadian market). Given that this may not change in the future, it makes sense for Canadian investors seeking highest returns and lowest risk to maximize the amount of foreign investments in their portfolio.