3. Now it’s time to purchase the investments. Start by buying your strip bond in the amount of $44,399. Then use your remaining $5,601 to purchase an equity ETF such as the Horizons S&P/TSX 60 ETF (HXT), which tracks its index almost perfectly and conveniently reinvests all dividends.
Now, unless your bond defaults, you are guaranteed to have $50,000 in six years, plus some additional return that is tied to the performance of large-cap Canadian stocks. But unlike the structured note, there is no limit on that potential upside: your $5,601 will capture everything the index delivers, minus only the ETF’s minuscule fee.
Plus, you don’t have to rely on a 24-page offering document or Newtonian calculus to get an idea of your potential returns. My spreadsheet calculates these based on several scenarios, using both negative and positive values for the ETF. For example:
|
Annual |
Final |
Overall |
|
ETF |
portfolio |
annual |
|
return |
value |
return |
|
-5% |
$54,118 |
1.33% |
|
-1% |
$55,274 |
1.69% |
|
0% |
$55,601 |
1.79% |
|
1% |
$55,946 |
1.89% |
|
5% |
$57,506 |
2.36% |
|
10% |
$59,923 |
3.06% |
|
|
|
|
As you can see, if the S&P/TSX 60 delivers a modest 5% annually over the next six years, you would end up with $57,506, which works out to an overall return of 2.36% annually. Hardly awe-inspiring, but significantly better than you would have received from the strip bond alone—and likely more than you would have received from the structured note. Of course, it also came with a guarantee: even if the ETF were to suffer a 5% loss every year, your overall annual return would still be 1.33%, about the same as you would get today from a high-interest savings account.
This strategy is more appealing when interest rates are higher and the horizon is longer. Corporate strip bonds that mature in 10 years, for example, pay about 3.5% today. Using my spreadsheet, you’ll see that you could guarantee your $50,000 over a decade with a bond purchase of $35,446. If equities return 6% over the next 10 years, your overall annual return would be 4.28%. If they deliver 8%, your investment would grow to $81,421, for a 5% annual return. That’s not bad for an uncomplicated investment that comes with almost no chance of loss. Any idea why the banks aren’t recommending it?