STRATEGY SHEET
September 1995
Real Risk
vs. Guarantees
© Talbot Stevens
True or false: “Investments that offer the greatest returns have the greatest risk.”
After decades of hearing the above half truth, it is not surprising that Canadians are conservative investors who love GICs.
Conventional risk vs. return theory tells us that cash-type investments like GICs are ‘low risk, low return', and that the stock market is ‘high risk, high return'.
This conventional risk/return relationship is generally true for short-term evaluations. But real risk can only be defined relative to the length of the investment.
For short-term periods of less than five years, ‘guaranteed' investments do offer the lowest risk. But if we have a longer-term time horizon, as in retirement savings, then the relationship between return and total risk actually reverses.
Almost every long-term study of investments has consistently shown that the stock market outperforms bonds and GIC-type investments.
If you had invested $1,000 into 5-year GICs back in 1954, you would have averaged a little over 8%, and at the end of 1993, you would have had $22,500.
But if you had invested that same $1,000 into the stock market (TSE 300) which averaged about 11% a year, you would have over $63,000, almost 3 times as much.
And that's a before-tax comparison. For any non-sheltered investment, those outside your RRSP, the most important factor to consider is the impact of taxes. For someone in the 50% bracket, the after-tax difference between the stock market and ‘guaranteed investments' was a factor of 8.
So do you want to end up with a retirement fund 1/3 or 1/8 of what it could be, just so you can say that your investment never temporarily went down in value?
Of these two investment strategies, which gives you more security at retirement: $63,000 or $22,500? What is riskier: heading into retirement with a $22,500 retirement fund or one that is almost 3 or 8 times as much, depending on whether we're talking about your RRSP or non-sheltered funds? The answer is pretty obvious.
The bottom line is that to truly minimize your total risk, (to reduce the possibility of having much less than you could have), you need to choose the type of investment based on the length of the investment.
If you use investments that offer short-term guarantees for your long-term investment objectives, you're almost guaranteed to end up with much less than you could have in the long run.