Dale Jackson

Personal Finance Columnist, Payback Time

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The Bank of Canada decision to start raising its benchmark interest rate this week should come as no surprise to anyone who has been paying attention to their investment portfolios.

The alarm bells for higher borrowing rates have been sounding for over a decade after central banks slashed them to near-zero in the wake of the 2008 global financial crisis.

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Since then, rates have ebbed and flowed in a tug-of-war between inflation and recession. Most recently, it was the fear of a recession from pandemic-induced lockdowns that kept rates low. Now, concern over long-term inflation as restrictions are lifted have spurred this week’s increase.

For long-term investors saving for retirement, it’s neither good nor bad - just different. A properly-diversified portfolio should be flexible enough to adapt to the potential tectonic shift about to take place.
 

WHERE WE STAND

To put things in perspective, the Bank of Canada raised its rate this week by 25 basis points to 0.50 per cent. Major Canadian banks have already responded by raising their prime lending rates to 2.70 per cent, from 2.45 per cent.

Economists polled by Bloomberg expect the central bank to raise its rate to 1.75 per cent by the end of the year. What the Bank of Canada does after that depends on how the economy reacts to the current rate hikes and many other variables such as the impact of Russia’s attack on Ukraine.

If economic growth lags, further rate increases could be paused or even reversed. If growth and inflation continue to outpace expectations, we could eventually be heading for the double-digit interest rate era of the 1980’s …so, we’re pretty much exactly where we’ve been for the past decade.
 

FIXED INCOME IMPACT

If interest rates are headed for the stratosphere, we should have plenty of time to react. The first real signal for retirement investors will be rising bond yields, which could finally present an opportunity to shift portfolio holdings from volatile equites to safe, fixed-income products.

There’s an entire generation that has never known the joy of risk-free real returns in the five per cent range, or the comfort of maintaining return goals with their portfolios evenly split between stocks and bonds.

With fixed-income yields near zero, it’s been an agonizing decade for retirement investors having to venture up the risk ladder to find returns in equity markets such as in the form of stock dividends.

Unlike fixed-income, dividends are paid at the discretion of the company and the underlying stock is subject to price changes at the discretion of the market.

The stakes are even higher as more Canadian workplace pension plans shift from the safety of guaranteed payouts from defined benefit (DB) pensions to defined contribution (DC) pensions, which expose retirement savings to the whims of broader equity markets.

According to Statistics Canada, 48.4 per cent of employed men and 34.5 per cent of employed women were covered under a DB pension plan in 1977. At the time, DC pensions were virtually non-existent.

Today, the proportion of DB pensions has plunged to 21.4 per cent for men and 28.7 per cent for women. DC pensions and DB/DC hybrid pensions now apply to nearly 14 per cent of employed men and just over ten per cent of working women.

Overall workplace pension coverage has also declined over the years, leaving more Canadians having to supplement their retirement savings by investing in often volatile equity markets through their registered retirement savings plans (RRSP) and tax free savings accounts (TFSA).
 

STOCK OPPORTUNITIES

Equity markets tend to gradually price in rate hikes. Proponents of lower interest rates often interpret short-term selloffs as a sign equity markets don’t like higher borrowing rates, but it’s just stems from a fear over high rates may go.

It’s financial stability and the potential for profit that keeps equity markets growing. If you currently own companies with consistent and growing earnings, there’s no reason why they should not continue to grow in value and pay out dividends.

Finding the right stocks in a higher rate environment, keeping your portfolio diversified in any environment, and knowing when and how to adjust your asset mix between stocks and bonds is easier said than done for the average investor.

That’s when qualified investment advisors earn their fees.