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investor clinic

I want to invest in a guaranteed investment certificate, but I noticed something odd when shopping for rates at my discount broker. The yields offered on one- to three-year GICs are all more than 5 per cent, but four- and five-year GICs pay less than 5 per cent. Shouldn’t I be getting paid more, not less, to lock my money up for a longer time period?

Normally, that would be the case. Because investing your capital for a longer term carries more risk, you would typically earn a premium for doing so. Graphically speaking, if you were to plot the yields of one- to five-year GICs, the line would slope gradually up and to the right.

But these are not normal times. Now, the line slopes downward, meaning the lowest yields are paid for longer maturity periods. This is what’s known as an inverted yield curve, and it’s especially pronounced in the bond market right now.

As of Friday, Government of Canada bonds maturing in one year were yielding 4.39 per cent. Three-year bonds were yielding 3.56 per cent, and five-year bonds just 3.05 per cent.

An inverted yield curve is often said to signal an economic slowdown. Indeed, this is precisely what the Bank of Canada has been trying to engineer by hiking its short-term policy interest rate – including a half-point increase this week – in an attempt to get inflation back under control.

What the bond and GIC markets are predicting, essentially, is that interest rates will fall as the economy slows and the central bank wrestles inflation to the ground. That’s why you’re getting a lower, not higher, yield if you lock in a GIC for four or five years compared with a one- to three-year GIC.

Does this mean four- and five-year GICs are a bad deal? Not necessarily. If interest rates do start to fall, as expected, locking in now at a rate of, say, 4.8 per cent might turn out to be a smart move. You’ll continue to collect 4.8 per cent for many years even as yields on new GICs fall. There are no guarantees that events will play out exactly as expected, however.

To control your risk, one of the best strategies is to build a ladder of GICs. For example, you could invest equal amounts of your money in GICs with maturities ranging from one to five years. When the one-year GIC matures, roll the proceeds into a new five-year GIC, and so on. By staggering your maturities, you’ll avoid having all of your GICs coming due at the same time, possibly when interest rates are very low.

If I can earn 5 per cent on a one-year GIC with no risk, why would I want to invest in a stock yielding 3 or 4 per cent that might not even make money?

Well, if you can’t stomach any risk at all, then a GIC might be a good choice. But you’ve heard the expression, “no pain, no gain,” right? If you can endure the “pain” the stock market occasionally dishes out, you’ll likely be rewarded with some very nice gains over the long run.

Over the past 20 years – a period that included the financial crisis, a global pandemic and assorted other setbacks – Canada’s S&P/TSX Composite Index posted an annualized total return, from dividends and share price appreciation, of about 8.6 per cent. I don’t remember the last time GICs paid anything close to that, but I’m pretty sure it wasn’t during this century.

What’s more, thanks to the dividend tax credit, dividends from Canadian companies are generally taxed at lower rates than interest from GICs or bonds. For example, if you live in Ontario and have annual income of $100,000 for 2023, you would pay a marginal tax rate of just 12.24 per cent on eligible dividends, compared with 33.89 per cent on interest income. (Visit TaxTips.ca to see what marginal rates apply to your particular province and income level. Also note that, if you’re investing in a registered account, taxation is irrelevant.)

Now, I’m not suggesting you should avoid GICs altogether. If you will be needing the money in the next few years to buy a house or pay for a child’s education, for example, then parking your cash in a GIC makes a lot of sense. Allocating a portion of your portfolio to GICs can also help you sleep better at night. But if you are investing for the long run, you will likely pay dearly – in the form of higher taxes and lost capital growth – for the “safety” that GICs provide.

E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.

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