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Portfolio Strategy

In praise of a much maligned investment Add to ...

A lot of the investors who sought safety in bond funds in the past year made a choice that could eat into their returns and spoil their peace of mind.

If these people had bought guaranteed investment certificates (GIC) instead, they would quite possibly be making more money right now with less downside pain when interest rates start to move higher.

The GIC - is there a more underappreciated an investment product? By the time you finish this edition of the Portfolio Strategy, your answer will be an emphatic no.

Until the mid-1990s, GICs were the investment product of the masses. Then interest rates went into a long-term decline and investors started looking elsewhere for decent returns. That's pretty much the story of the rise of the mutual fund industry.

A year ago, investor interest in safe investments surged as the stock markets tanked. Bond mutual funds were the big hit with conservative types, along with bond exchange-traded funds and high-interest savings accounts. GICs? At Victoria-based GICDirect, sales slumped last March and only now show signs of recovery.

"I think GICs get a bum rap with investors," said GICDirect president Bill Ritchie. "I've said that for years."

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Mr. Ritchie's firm has been in business for about 10 years and during that time he said it has consistently been able to offer five-year GIC rates that beat comparable Government of Canada bonds. He said he couldn't verify whether GICs beat provincial bond yields, but I can.

CIBC Investor's Edge is one of a few online brokerage firms that offer GICs from a wide variety of third-party banks, trust companies and credit unions. This week, it had five-year GICs available from HSBC Bank and Laurentian Bank at 3.35 per cent. At the same time, Investor's Edge was selling a Government of Canada bond maturing in mid 2015, with a yield of 2.6 per cent and comparable provincial bonds with a yield of 2.8 per cent.

GICs also beat the yield provided by bond ETFs. The Claymore 1-5 Year Laddered Government Bond ETF (CLF-TSX) is designed to be a convenient substitute for finding government bonds with terms of one through five years and investing equal amounts in each. The best yield estimate for this product right now is about 1.9 per cent after fees. If you used one- through five-year GICs available from Investor's Edge, you could build yourself a laddered portfolio yielding an aggregate 2.4 per cent.

No, that's not a great return. You could do better with dividend-paying blue chip stocks, preferred shares, income trusts and so forth. But if you've been buying bonds and bond funds lately, you're probably too conservative for those.

Let's consider the safety factor. There's a supreme level of safety with bonds issued by governments, which can ultimately raise taxes to pay what they owe. With riskier corporate bonds, you're dependent on the ability of a company to pay what it owes.

GICs issued by virtually all financial institutions that deal with retail customers are members of Canada Deposit Insurance Corp. (CDIC), a federal agency, or provincial credit union deposit insurance plans. CDIC limits coverage to $100,000 in principal and interest per institution, but you can get around this by spreading your investments among various financial companies.

Bonds and bond funds beat GICs in two areas - variety and liquidity, which means the ease with which you can buy and sell them at a fair price.

With GICs, the key variables in choosing what to buy are basically rate, term and the reputation of the firm issuing them. There are some particular features to consider - like the option of being able to cash out before maturity without any hassles - but they're minor.

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