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Most investment advisers recommend having an appropriate mix of stocks, bonds and cash in an investment account.
But the odds are that whatever your original allocation, your bond weighting has drifted below your target. That’s market gravity at work. Equities have outperformed bonds (and cash) by such a wide margin in recent years, that unless you have been rebalancing on a regular basis, your percentages are now out of line with your original goals. The result is a higher degree of portfolio risk than you may be comfortable with.
Bonds are sometimes referred to as the “great stabilizer” in a portfolio. They serve as a brake when stocks hit a wall. Consider what happened in 2008, when the financial crisis rocked the stock market. Steadyhand’s volatility metre shows that a portfolio holding 80 per cent stocks and 20 per cent fixed income would have lost 22.3 per cent that year.
But if the mix was 60 per cent stocks and 40 per cent fixed income, the loss would be reduced to 15.2 per cent. A portfolio that was 80 per cent fixed income and 20 per cent stocks would have finished the year close to break-even.
That doesn’t mean you should be overloading your portfolio with bonds. They’ll drag down your returns in years when the stock market is doing well. But if your portfolio has strayed from your original asset mix, rebalancing will act as an insurance policy if equities run into trouble.
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That will require discipline. Fixed income securities have not been exciting places for your money this year. As of Dec. 19, the FTSE Canada Universe Bond Index was showing a total return of only 2.24 per cent, year-to-date. No one will be thrilled with that.
But drill a little deeper and you may be surprised. The Short-Term Bond Index is up 3.69 per cent this year. That’s a decent return, especially when you consider that short-term bonds carry the lowest risk. You can do even better if you seek out corporate short-term issues. As a group, they are up 4.58 per cent this year.
An easy way to invest in this segment of the bond market is to buy units of the BMO Short Corporate Bond Index ETF. It’s a low-cost, low-risk fund that has been generating very good returns in recent years. Here are the details.
BMO Short Corporate Bond Index ETF (ZCS-T)
Type: Exchange-traded fund
Price: $14.05
Annual payout: $0.54
Yield: 3.8 per cent
Risk: Low
Website: www.bmogam.com
The security: The fund has been designed to replicate, to the extent possible, the performance of the FTSE Canada Short Term Corporate Bond Index, net of expenses. It tracks a variety of debt securities with a term to maturity between one and five years. Securities held in the index are generally corporate bonds issued domestically in Canada in Canadian dollars, with an investment-grade rating.
Performance: As of the end of November, the fund was showing a year-to-date total return of 4.81 per cent. The three-year-average annual compound rate of return was 6.18 per cent.
Key metrics: The fund was launched in October, 2009. It has $4.3-billion in assets under management and a MER of 0.11 per cent.
Portfolio: There are 577 positions in the portfolio. Only one, a Scotiabank bond maturing in 2027, makes up more than 1 per cent of total assets. Almost 58 per cent of the assets are bonds issued by financial institutions. About 90 per cent of the investments are rated A or BBB.
Distributions: The units are currently paying $0.045 a month ($0.54 a year), but that could change any time.
Tax implications: In 2024, most of the distributions were treated as “other income” for tax purposes, meaning the payments are virtually 100-per-cent taxable if received in a non-registered account. Consider using a registered retirement savings plan, a registered retirement income fund or a tax-free savings account for this position, if possible.
Summing up: If you need to do some portfolio rebalancing by adding bonds, this is a good way to do it. But be ready to sell if interest rates start to rise.
Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters.