Are GICs a substitute for bonds?

Laddered GICs can replace bonds in a balanced portfolio.

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From the February/March 2014 issue of the magazine.

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Few investments are easier to understand than the humble guaranteed investment certificate: you invest a lump sum for one to five years and collect a fixed rate of interest until maturity. Many investors wonder if a five-year GIC ladder might replace bonds on the fixed-income side of a balanced portfolio. The answer is yes.

In fact, GICs have several advantages over bonds:

1. Simplicity. GICs are easier to purchase than government or corporate bonds. They’re widely available through online banks, credit unions and deposit brokers, as well as discount brokerages. And their pricing is transparent: while GIC issuers do pay a commission to the dealer, the yield you’re quoted is exactly what you’ll earn, making comparisons easy.

2. Higher yields with no additional credit risk. GICs are backed by the Canadian Deposit Insurance Corporation (CDIC), so they have no default risk on amounts up to $100,000. That makes them no riskier than Government of Canada bonds of the same maturity, even though they usually have higher yields.

3. Stable prices. While bond prices rise and fall with changes in interest rates, GICs have stable prices that many investors find comforting. This price stability is mostly an illusion: if interest rates rise after you’ve locked in a GIC for four or five years, you’ve paid an “opportunity cost.” But there is value in not having to watch your holdings fluctuate like bond mutual funds or ETFs do.

4. Tax efficiency.If you’re holding fixed income in a non-registered account, GICs are almost always a better option. Most older bonds trade at a premium these days, which means they are priced above face value because their coupons are higher than those of newly issued bonds. In an RRSP or TFSA this isn’t a concern, but premium bonds (and funds that hold them) are extremely tax-inefficient in non-registered accounts. GICs never trade at a premium and have lower interest payments, making them a smarter choice in taxable accounts.

GICs do have some disadvantages: they are usually not liquid, meaning you can’t sell them before maturity without penalty. They also have no potential to rise in value if interest rates fall, so they can’t be relied on to offset losses during a stock market downtown.

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