As Stephen Poloz begins his tenure as the new governor at the Bank of Canada, there has been a lot of talk about Mark Carney’s last policy decision to hold the interest rate steady at one percent. While the rate addresses the expectation of moderate growth in the Canadian economy, it also forms the basis of the saving and lending rates that banks pass on to their customers.
With rates not expected to move anywhere, any time soon, the question is: “How can the average Canadian make any money from their investments?”
To answer that, let’s take a look at how people think of ‘risk’ and ‘investing’.
I come across a lot people who have been taught to equate the idea of ‘risk’ with losing their money. A common fear is that if they invest in the stock market, they might lose their money. But is that really what you have to worry about? I don’t think so.
When you retire, you will need income. At the same time you have to protect the purchasing power of your income and assets. Let’s look at two scenarios:
Say you have $100,000 to invest. You take your money to Royal Bank and purchase a five-year term deposit that will pay you 4 per cent. Although 4 per cent today is not offered let’s pretend that you were getting $4,000 per year, which will provide you with $333 per month. Because you’re retired, the $333 is going to form part of your retirement income.
At the end of five years, you go back to the Royal Bank and cash out your term deposit. Now, here’s the question. At the end of five years, what’s the probability that your investment is going to have increased in value? Would you agree the answer is zero? Since you spent the income, the principal you invested will be returned — and while true — you didn’t lose your money, what you’re not seeing is the invisible thief: inflation.
Let’s make a different investment. Let’s take the $100,000 and buy $100,000 of Royal Bank common shares. At today’s price, that would give you about 1,800 shares and pay you a dividend of about 4 per cent. Now the same question — at the end of five years, what’s the probability that your investment is going to have increased in value? Is it 10 per cent probability? Maybe 20 per cent? How about if we extend the time frame to 10 years or 20? What do you think the probability is that your Royal bank common shares will be worth more in the future? I say the probability is pretty good. Maybe even 100 per cent if you look far enough into the future.
Some of you are going to say that the dividend isn’t guaranteed, and that at the end of five years the stock price may be lower then today. Both would be true, but here’s the point. If you know that buying term deposits stands zero probability of increasing in value, isn’t that a doomed strategy? Doesn’t it make more sense to invest in something like real estate or RBC common shares, as something that at least stands a chance?