Dividend funds help recession-proof RSPs

With the market’s current volatility, it’s likely some Canadians are worried about their RSPs. But just because stocks are down doesn’t mean your future has to kick the bucket too.

Gavin Graham, chief investment officer of Guradian Group of Funds, says investing in a dividend fund is a great way to recession-proof your RSP. “When you put money in dividend-paying stocks, you’ll get the dividends regardless of whether the market is going up or down,” he says. “You’re buying well-established companies with good balance sheets.”

He explains that a company’s giving out a dividend usually means it’s healthy and confident, especially if it has increased its payout this year. So sticking with that business is a safe bet, even if its stocks have dropped.

“It goes beyond dividends,” adds Martin Hubbes, chief investment officer at AGF. He says strong companies have a better chance to weather the downturn. “Certainly, when the clouds lift and markets pick up again, those will be the companies that give a strong performance.”

Some clients might be hesitant to put their RSPs into a bank dividend fund, especially because the banks have dropped 20% since the market turmoil began. But Graham says yields on these funds are actually better than what people can get from a government bond — about 4.75% for banks versus 3.82% for a 10-year Canada bond. “When a client invests in dividends, what they’re saying is ‘I don’t care about what the price does because I get yield substantially higher than anything I can get in a GIC, a bank deposit or buying a government bond from the biggest and most profitable financial institutions in the country.”

He adds that banks haven’t cut their dividends in 25 years.

Investing in REITS is also a good way to protect an RSP investment, says Graham, because not only do they pay dividends but their price has fallen significantly in the last year. “A year ago they were at a 20% premium to the underlying asset value; now they’re at a 20% discount, and interest rates are going down,” he says. As well, Canadian REITS haven’t been affected by the crumbling real estate market in the States, so investments here are relatively safe.

Like with any type of investing, staying diversified and looking long-term is key, and RSPs are ideal for those who like to stick it out. “I think RSPs are at an advantage,” says Hubbes. “For most people, it’s a 10-year investment. When put into a longer context, the volatility is not that meaningful. People thinking about RSP investments today have the luxury of time on their hands.”

Christopher Hatherly, a a financial planner with IPC, says he generally doesn’t do anything specific with his clients’ RSP investments during market downturns because of the short-term nature of volatility.

“Recessions are a natural part of the economic cycle,” he says. “They’re usually associated with depressed markets and as a result are a good entry point for long-term equity investors.”

He says RRSP portfolios usually have a value-based orientation, which means value investors are already looking to buy stocks at lower prices. “If a recession hits and the markets go down, there is, in theory, a downside cushion already priced into the stock, making the portfolio less volatile than the market,” he says. “Even though the markets may go down, value stocks generally will not go down nearly as much as the overall market, leading to an element of downside protection.”

Investing in emerging markets is another way to help protect RSPs from a recession. Graham says many Asian companies, such as Hong Kong Bank or China Light and Power, are still strong and pay “pretty good” dividends — around 5%. “Dividends are a good thing whether you’re in Canada, the U.S. or emerging markets.”

“People haven’t given up on emerging markets,” says Hubbes. “People appreciate it’s going to be a choppy ride with emerging markets, but there’s a fantastic 10- or 20-year story here that investors need some exposure to.”

While clients might be excited about the extra income dividends can provide, they’ll be happier to know that in the case of RSPs, the cash is reinvested, helping the contributions grow further. That’s especially good news during troubled markets. “You’re compounding as dividends get reinvested, so you’re buying more each time because it’s getting cheaper,” says Graham. “You almost want the price to go down because it allows you to buy more.”

While dividend investing sounds like a good way to go, the bottom line is that clients need to put their contributions in something that’s long-term. With $4.5 billion going into money market funds in January, it’s looking as though clients need a little encouragement to stay the course. “The real problem is people saying that they’re going to put cash in money markets and when they hit the trough, they’ll put it back into the market,” says Hubbes. “But you only know that you’ve been through the trough when you look backwards. Advisors know they need to make that case, but making that case to the client seems to be a real challenge.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com

(02/15/08)

Bryan Borzykowski