The past decade of minuscule interest rates has been tough on retirees and those approaching retirement. As someone who doesn’t believe in taking more risk than you need to, I’ve always thought that putting a good portion of your fixed-income investments into Guaranteed Investment Certificates (GICs) would make sense if yields became decent.
My own advisor concurs, but this interest-rate yield desert suggests that it may be worth it to take what you can get on 2-year GICs and just keep rolling them over as they come due. About six months ago, it finally seemed the worm had started to turn and you could even get as high as 3% on some 2-year GICs.
As things have turned out, that might have been a good time for GIC buyers to extend the GIC term to 5 years; rates quickly backed down again and today you’d be lucky to get 2.5% on a 2-year GIC. And the reward for extending to a 3- or 5-year term is scant—you might only get 5 or 10 basis points in return for locking in with minimal flexibility.
“I was looking at GIC rates last week and my jaw dropped,” said my advisor, who does not want to be named. “They give you 0.05% more interest for going out a year from 2 to 3 years, and going out to the 5-year-term gives you only an extra 0.15% more per year. Not worth it.” But there’s not much you can do about this without chasing yield and getting into trouble with riskier investments. Remember, the role of fixed income is to provide stability to a portfolio and reduce its risk; chasing yield means doing the opposite.
GICs are attractive because they’re easy to buy, require minimal research and are ideal for meeting a fixed expense with a specific time frame. Plus, they are backed by the CDIC: the Canada Deposit Insurance Corporation insures eligible deposits at each member institution to a maximum $100,000 (principal and interest combined) per depositor per insured category. That amounts to a government-subsidized arbitrage opportunity, which is why investors with more than that like to spread GICs among different financial institutions.
One variant of GICs worth considering is cashable GICs. I found a cashable 1-year GIC at TD Bank that pays about 1.5%. This may be appropriate if you think you’ll need the money in less than a year, and its return is a lot better than the effective zero-interest rate you get on cash building up in bank accounts and brokerage accounts at your financial institution.
But there are alternatives. At least one advisor I spoke with much prefers fixed-income ETFs to GICs, despite the popular view that with GICs you never lose your principal. You’ll notice that while GIC ladders are invariably in the green, it’s not unusual for bond GICs to be in the red when interest rates are fluctuating. But this in itself should not be alarming. I refer readers to an excellent video by certified financial planner and CFA Charterholder Ben Felix, an Ottawa-based portfolio manager for PWL Capital. The video can be found as part of his Common Sense Investing YouTube series here.
Felix notes that many investors believe bond funds are risky in rising rate environments (because they may lose your capital), while individual bonds and GICs guarantee your principal. While true, this is also misleading, Felix says: “We must always remember that what matters is total return; holding a lower-rate GIC after a rate increase still results in an economic loss.”
Simply put, bond returns consist of principal, interest payments and reinvested interest, so focusing only on return of principal misses the point. Individual bonds are not ideal for individual investors, as they require extensive research, are relatively expensive and tricky to trade. But short-term GICs miss out on the term premium, which is substantial over time. Going back to 1985, Felix says short-term bonds returned 6.51% annualized versus 7.97% for the aggregate bond universe (which includes some short-term bonds). This shows how much mid- and long-term bonds increase your overall return.
GICs* are also illiquid, so even if an investor chooses to include GICs in a portfolio, they will generally also include bond ETFs, which—like stock ETFs—can be sold any trading day. Nor do GICs provide exposure to global bonds. Canadians get 90% of their bond exposure from Canadian bonds, even though they make up only 2% of the global bond market. Felix likes the Vanguard asset allocation ETFs, which hold Vanguard global and U.S. bond funds hedged to the C$. You may not need much global fixed-income diversification, Felix says, “as long as you have some.”
The bottom line? Total return matters. GICs might help you sleep better, but bond ETFs do a better job at boosting expected returns in this seemingly endless era of low-interest rates. That’s likely the best reason to have a bit of both.
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