The long and short of investing for retirement

(February 2008) RRSPs are a long-term issue, yet the savings season, with its often frenetic pace and abrupt deadline, can feel very much about the here and now. So how do we keep our clients focused on the long-term goal of retirement when they are being bombarded with headlines about poor near-term economic performance?

It’s easy for us industry types to ignore the calls to panic — we live through economic and market fluctuations day by day — but clients need to be reminded not only that these ups and downs have occurred in the past but that they will continue to happen.

Economists and policy-makers have tried valiantly to come up with ways to eradicate market volatility permanently. They have had some successes with economic cycles, which many would argue are not nearly as sharp as they used to be. But it is difficult to see a time when markets will not jump around because market fluctuations reflect changing economic and financial conditions. That means clients need the best possible investment expertise (remember that not all financial institutions got caught with bad financial paper). It can be especially helpful to explain investment basics to clients — how, for example, a specific investment is likely to fare during a period of economic slowdown.

Of course, investment expertise needs to be matched with the client’s personal needs and characteristics. Clients need more education as to what risk really means. I am convinced that educating clients as to what risk is, and what it means to them, is the most difficult part of client education. Clients also need to understand that while Canada will undoubtedly be affected by the slowdown in the U.S. economy, economic conditions here are more positive than those in the U.S. and are likely to remain so.

To put today’s markets in perspective, it is always good to review what came before. In past times of market volatility, central banks have lowered interest rates and governments have often helped with additional spending or tax cuts — just as is happening now. However, whenever people talk about past periods of economic slowdown, and the strong and sustained recoveries that followed, there is always someone in the room who will invariably say, “But it’s different this time.”

But is it different? We have seen housing slumps before, in both the United States and Canada. So today’s housing slowdown is not necessarily different than past experience. What has changed is that we now know that one of the forces powering the U.S. housing boom was a relaxation of credit standards that went way too far. We also know that the securities containing sub-prime mortgages were lacking in transparency — i.e., it wasn’t made clear just how much in the way of sub-prime mortgages were in some of these securities (in addition to other types of less-risky loans such as credit card or auto loans).

We also know that financial markets weren’t expecting the extent of the sub-prime mortgage problems or the large write-downs by financial institutions that were involved with these securities. As a result, markets, which absolutely hate being surprised, are extremely skeptical and concerned that they don’t yet know and understand all of the problems that are or may be out there. Until the markets are convinced, there is likely to be continued volatility.

There are other differences between “then and now” that are enormously positive. For example, there is widespread agreement among the analytic community that both the Canadian and U.S. economies are more structurally sound — more robust and able to withstand economic disruptions — than they were 20 or 30 years ago. Proof of that can be seen in the recoveries from the late-1990s Asian crisis, the dot-com bust and the 2001 terrorist attacks. Another positive difference is that this time, U.S. exports are finally growing in response to the fall in the U.S. dollar that began some six years ago, and net exports (exports minus imports) made a positive contribution to U.S. economic growth in the fourth quarter of 2007. While many are understandably concentrating on what is currently wrong with the American economy, the apparent turnaround in net exports bodes well for improved U.S. health over the long term.

There are also several factors that are similar to past economic downturns this time around. Consumers, especially in the United States, are understandably nervous, particularly the ones who purchased houses at or near the peak of the U.S. residential market. Companies are showing some reluctance to invest when they are not sure how anxious consumers will be to spend. Another factor on the “same” side of the ledger is that equity markets are paying close attention to company earnings. This is worth mentioning because it is in sharp contrast to what was happening during the dot-com boom, when future earnings expectations were a major market driver while current earnings were all but ignored.

So where does this leave investors who are looking long term and need to get the best possible returns to ensure a comfortable retirement? For one, they should not abandon equity markets. Obviously, the extent to which any specific client is invested in equity markets is a function of his or her time horizon and risk tolerance. But when the markets are volatile, it is hard to keep this perspective.

One of the ways that advisors might put market fluctuations in perspective is to remind clients that investing isn’t the only part of our lives subject to roller-coaster rides — careers and personal relationships often experience the same ups and downs. Make this clear to your clients, and they’ll be able to look ahead and stick it out until retirement.

Peter Drake is vice-president, retirement & economic research, for Fidelity Investments Canada. With over 35 years of experience as an economist, he leads Fidelity’s research efforts in retirement in Canada today. He can be reached at peter.drake@fmr.com.

(02/08/08)