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Are Bank Stocks the Key to a Secure Retirement?

Andrew Button

Investing for retirement is all about security. Though it can be fun to speculate, your retirement account is not the place to do it. There is some room for high-volatility plays when you’re younger, but you should put emphasis on minimizing risk as you approach your golden years. And if you must gamble — at any age — you should keep your speculative plays far, far away from your RRSP.

So, if you’re building a retirement portfolio, the question you should ask yourself is:

“How do I identify the stocks that give me adequate safety, so I know my money will be there when I retire?”

First, one thing bears mentioning: you should always discuss these matters with your financial planner. Everybody’s financial situation is different, and different stocks suit different investors’ risk profiles and goals.

But in general, if you’re looking for an easy, safe sector to invest in, Canadian bank stocks would be a great place to start. I’ll outline three reasons, starting with a structural one.

Regulation and competition

The Canadian banking industry is heavily regulated, with strict rules governing everything from mortgage lending to small business loans. Your first reaction to this might be, “isn’t that a bad thing?” And if your rubric is growth, then the answer is yes: Canadian banks don’t deliver the frothy returns of their less-regulated American counterparts.

But American banks also experience higher volatility and greater risk. During the Great Recession, several American banks filed for Chapter 11 bankruptcy. Not a single Canadian bank suffered a similar fate. This fact can be attributed to tighter regulations in the Canadian banking industry: the need to comply with strict rules makes it less likely for banks to issue high-risk loans. Canadian banks never had the practice of sub-prime mortgage lending, for example. The end result? Stable, steady returns — the kind of performance ideal for a retirement portfolio.

Discount valuation

Many Canadian banks trade at low P/E ratios. Canadian Imperial Bank of Commerce (TSX:CM)(NYSE:CM), for example, had a P/E of 10.75 at the time of this writing (four of the other “Big Five” had P/E ratios below 15). This is partially attributed to the modest earnings growth in the sector. But that’s not always the case: CIBC has both a low P/E and year-over-year earnings growth of 25% (as of the quarter ended March 30).

Income plays

All five of Canada’s biggest banks pay dividends, and often quite handsome ones. Bank of Nova Scotia  (TSX:BNS)(NYSE:BNS) pays an annual dividend of $3.28 for a yield of 4.26% at the time of this writing. This is well ahead of the TSX average and well ahead of inflation. If you invested in Bank of Nova Scotia and reinvested your dividends for the next five years, you would stay ahead of projected inflation rates even if the stock stayed flat! This is the kind of security you want in your retirement portfolio.

Bottom line

Canada’s banking system is known for stability, security, and consistent returns. Volatility is low, and regulations are tight. There are very high barriers to entry, which means competition is low. And the sector as a whole has a very long-term track record of delivering solid returns. All of these qualities make Canadian bank stocks a great bet for investors nearing their golden years.

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Fool contributor Andrew Button has no position in any of the stocks mentioned.