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Like Smaug, the dragon in The Hobbit who guards his pile of treasure, perhaps the biggest priority for high-net-worth investors is to preserve their wealth. They are usually happier to sit on their capital than grow it dramatically.
Yet capital preservation isn’t just for the ultra-wealthy. It is also the priority for many investors, including retirees concerned they will outlast their money.
So whether you’re a big dragon or an investor of more modest means, consider these five strategies to preserve your pile of loot.
Quality over promise of quantity
Yes, yields on GICs and other fixed-income investments are low – they often barely keep up with inflation – but investors need to be aware of the risks of stretching for yield, says Darren Coleman, portfolio manager with Coleman Wealth, a division of Raymond James Ltd., in Toronto.
“It is very tempting, in both stocks and bonds, to try to juice returns by buying lower-quality investments,” he says. If GICs are paying around 1 per cent, then a bond paying 6 per cent has a lot of risk attached to it.
Investors seeking to protect capital often face the challenge of trading one risk for another. So, while a GIC-heavy portfolio may not keep pace that well with inflation, investors should keep in mind that, when compared with capital losses, it is likely the lesser of the two risks.
Be a landlord
Real estate offers advantages to individuals concerned about preserving wealth. For one, property tends to hold its value; prices generally fall less than other assets in a downturn.
Secondly, it can provide a steady income at higher rates of return than most fixed-income investments, Mr. Coleman says.
But rather than buying an entire property, investors can more easily purchase shares in a real estate investment trust, or REIT.
Besides diversifying your risk beyond one asset into a basket of many properties, REITs allow you to invest in real-estate sectors you might not be able to purchase on your own, such as office towers, shopping malls and retirement homes.
Be aware, however, that “REITs do have exposure to both the business cycle and overall interest rates,” Mr. Coleman adds. As rates rise, for example, REITs’ value and distributions can both fall.
Portfolios are ever-changing. Even though one may be set up to protect wealth – leaning primarily toward bonds, for example – the investment mix can get out of balance as markets rise and fall, and some investments outperform others.
That’s why regularly reviewing and rebalancing one’s asset allocation is a basic but crucial wealth-preservation strategy, says Rob Tetrault, a portfolio manager with National Bank Financial in Winnipeg.
“Every time the market rallies and your asset allocation gets out of whack, by rebalancing, you take some profits off the table, reduce your exposure to markets, and protect yourself in the event of a market correction.”
Selling some stocks with large gains, for example, and investing the profits into unloved fixed-income vehicles can help protect wealth because you are realizing profits and then allocating that growth to less risky assets.
Annuitize your income
The rises in interest rates over the summer have made annuities more appealing to investors, of whom fewer are going into retirement with a defined-benefit pension plan that could provide steady income.
“People are living longer, and they want to make sure their money lasts as long as they do,” says Jean Salvadore, director of insurance wealth strategy at Royal Bank of Canada Insurance.
To deal with longevity risk, consider creating your own pension plan with an annuity. In exchange for a lump sum of capital, you receive a regular benefit for a set term – such as 20 years, or until death.
Annuities are particularly helpful “if you have a certain amount of fixed expenses you want to cover through retirement,” Ms. Salvadore says. “It guarantees you that fixed amount every month.”
Still, an annuity involves giving up a chunk of capital in exchange for the income. Individuals concerned with leaving a legacy after they die can add guarantees – which come at a cost – to pay a beneficiary, Ms. Salvadore says.
Some investments can provide insurance against falling markets and help keep capital intact. Among the choices are segregated funds, which are essentially mutual funds with guarantees protecting the initial investment. Ms. Salvadore says these vehicles are good for grandparents who “want to set aside money for the grandkids” while also getting some of “the upside of the market.”
Should the market tank “or should you pass away, the beneficiaries will get at least 100 per cent of what you put into the fund,” she adds.
These guarantees come with added cost, however, embedded within the management expense ratio, or MER. Investors should evaluate whether the performance justifies the fees.